Tag Archives: sovereign debt

Commission’s Consultation on Bank Failures – Too Little, Too Late?

The European Commission has launched a consultation on technical details underpinning a European crisis management framework for the financial sector. The main measures proposed:

  • Preparatory and preventative measures such as a requirement for recovery and resolution plans and powers for authorities to require banks to make changes to their structure or business organisation where such changes are necessary to ensure that the institution can be resolved;
  • Powers for supervisors to take early action to remedy problems before they get out of hand such as the power to change the managers;
  • Resolution tools which empower authorities to take the necessary action, where bank failure cannot be avoided, to manage that failure in an orderly way;
  • A framework for cooperation between national authorities.

The two main principles proposed by the Commission are:

  • Effective arrangements which ensure that authorities coordinate and cooperate as fully as possible in order to minimise any harmful effects of a cross-border bank failure, and
  • Fair burden sharing by means of financing mechanisms which avoid use of taxpayer funds.

Now, the problem is that we already have a situation that may well get out of hand. Fortune has quoted Scott Minerd, chief investment officer at Guggenheim Partners, who thinks the entire banking system of Europe could be on the brink of disaster (I recommend reading the whole article). If this is true, the Commission’s initiative will not have the time to translate into meaningful EU policy. More, the proposal is not sufficient to solve the problems of the EU banking sector, which is heavily exposed to sovereign debt.

Scott Minerd says that it’s now up to Germany to take leadership in organizing a fiscal union and creating a common EU bond. He rightly points out that this means a true federalization of the European Union, since fiscal policy will be, to some extent, managed on EU level.

In other words the impending banking crisis in the European Union could result in a true federalization – the dream of the founding fathers of the EU. But it sounds simpler than it actually is. Many things can go wrong, and the markets are not exactly ready to accommodate the Hamletian dilemmas of EU Member State governments. The recent approach of Germany and France to coordinate positions and try to sell them as unconditional proposals is not sustainable. EU governments should discuss options multilaterally, taking into account varying positions and nuances. We need true European consensus on fiscal governance, not empty declarations on the centrality of the Economic and Monetary Union.

The Importance of Bank Stress Tests Results

European banks are mostly endangered today because of the sovereign risk – the risk that an EU Member State might default. The banks have bought lots of government bonds from different EU governments, and now we want to know how much capital they need in order to stay solvent. That is why we need to conduct bank stress tests.

A bank stress test is intended to give an overview of the possible bank performance in case some serious risk materializes. This risk is called a “stress scenario”, and banks calculate if they’ve got the capital reserves to cover losses.

There is news that the results of ongoing tests on European banks will be published on 23 July. Markets need those results in order to get the real snapshot of the EU financial system, and to calculate the risks and perspectives for the EU economy.

But the stress tests results must be useful and transparent if they are to calm the markets. One of the issues is to include all systemically important banks. But the stress tests must also include really worst-case scenarios, as Wolfgang Münchau has argued. Designing stress tests in such a way that the banks will pass them will not convince the markets. Additionally, the stress tests results must be published in full – guaranteeing the transparency of the procedure.

The stress tests are probably the only tool we now have to convince financial markets that EU banks are stable. That is why any improvisation should be avoided.