Wednesday, July 25, 2012
Europe needs a bigger crisis firewall
July 25, 2012
European leaders are attempting to get ahead of a festering financial crisis by breaking the negative feedback loop between banks and sovereigns.
Having agreed an ambitious timetable for common bank supervision in June, the European Council has formally launched a two-front war in the push towards deeper currency union. Banking union has now leapfrogged fiscal union as a priority.
Two wars require more ammunition and a solid strategy. By imparting more responsibilities without additional resources, the European Stability Mechanism, the eurozone’s permanent bailout fund, is being enfeebled. Each tap of the facility, which can lend up to €500bn against €80bn in paid-in capital, will tend to underscore how ineffectual the firewall is as a bulwark against multiple risks: sovereign default, bank runs and currency redenomination risk.
The initial focus on direct ESM bank recaps reflects a bad strategic choice: common deposit insurance would be a much more effective and immediate tool in breaking a related link between private funding for banks and subsequent stress on sovereign borrowing costs. But common deposit insurance has been rejected because it mutualises insurance against bank runs. And thus the risk of runs against the periphery remains high.