Vox
June 6, 2012
In Greece, the problem is an insolvent government bringing down the banks. In Spain, the problem is now insolvent banks bringing down the government. This column argues that despite their differences, the potential costs to the rest of Europe mean that both problems require a European solution.

- In Greece, it is the insolvency of the government that has sunk the banks;
- In Spain, the banks are sinking the government.
We argue that in the case of Spain’s banks, their dire need of capital can only be provided by a European institution, the European Stability Mechanism (ESM). Likewise, given that the Greek government is in no position to prop up its banks, only the ESM can save the Greek banking system. In both cases the ESM, the ECB, and the national central banks should then take control over the banks they have recapitalised, probably best achieved through a new special purpose vehicle (staffed by experts from European Banking Authority).
For the medium term, the creation of a European Deposit Insurance and Resolution Fund (EDIRF) could make the European banking system more resistant to national shocks and the contagion from the Greek and Spanish cases (see our recent research, Schoenmaker and Gros 2012). However, the crisis in both Greece and Spain are threatening the survival of the system today and thus require an immediate solution, before the long-run solution can be made operational. The special purpose vehicle used for immediate intervention in Spain and Greece could later be merged into the future EDIRF.
The Commission’s proposals seem again to be a case of ‘too little too late’. The idea of having some co-insurance among national deposit guarantee systems in case a bank with pan-European activities gets into trouble might be useful. But this assumes that there will be any pan-European banking groups left in the Eurozone. The ‘balkanisation’ of the Eurozone’s banking system is progressing now so rapidly that this might soon no longer be the case. Moreover, the problem today comes from local banks, both in Greece and in Spain (where the internationally active banks do not seem to have been heavily involved in real estate lending). In Ireland, the losses came from banks that were mostly local in their activities.
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