Vox
December 22, 2011
Despite emergency summits and last-minute reforms, there is still a large question mark hanging over the euro. This column argues that a chief cause of this is the management of Europe’s banks. It epitomises many of the contradictions at the heart of the Eurozone and unless resolved could be the cause of a slow and painful death of the single currency.
The Eurozone crisis keeps evolving along multiple dimensions. On the sovereign debt front, no deal is yet in sight on Greece’s debt restructuring, and Italy and Spain face major refinancing needs in early 2012. On the institutional reform front, the summit on 8-9 December fell short of delivering a true fiscal union (O’Rourke 2011), and tensions between the Eurozone and the UK have been brought to boiling point. On the growth front, a possible deep and prolonged recession looms.
As during previous episodes, however, the banking system is a crucial piece of the puzzle and epitomises many of the contradictions of Europe’s experiment in monetary union. Since 2007, that system has almost continuously exhibited worrying gaps in risk management, compounded by massive supervisory failures in some countries. In the past two years, deteriorating sovereign creditworthiness has increased the system’s fragility. The combination of member states’ guarantees on domestic banks, and those banks’ outsized holdings of home-country sovereign debt in periphery countries, has accelerated the feedback loop between sovereign credit and bank funding conditions. The result is fragmentation; whether a euro held in a Greek bank is equivalent to a euro in a German bank is ever more in doubt. This could produce a slow-moving death spiral for a currency union.
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