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PIIE: New Hope on Banking Regulation in Europe

Author: Jacob Kirkegaard
April 4, 2012

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After so many bungled interventions, regulatory failures, and taxpayer funds wasted, Europe seems more intent than ever on finally doing something constructive about its banking sector.

The EU finance ministers met on March 30th and March 31st and—as predicted here—agreed to increase the euro area "firewall" in accordance with the expressed wishes of the G-20. Despite the press focus on the firewall's size, however, this step was not the most important item on their agenda to achieve the longer term stability of the euro area. Far more important was the ministers' discussion of a pan-European banking resolution framework.

Bear in mind that whatever the euro area decides will disappoint many financial market and media analysts.1 This group consistently looks for a risk-free outlook and assurances that investors will always be bailed out. As a result, anything short of a firewall that could cover the entire financing arrangements for Greece, Portugal, Ireland Spain, Belgium, and Italy lasting three years is inadequate and a sign that the euro area does not get it. (Three years is the usual length of an International Monetary Fund standby arrangement, typically estimated at least Ä1.5 trillion.)

Whether the firewall to be established is Ä500 billion, Ä700 billion, or Ä1.5 trillion, calls for ever larger amounts are based on an erroneous assumption of bottomless pockets for the core euro area pockets. They assume that Berlin and other northern European capitals have the capacity to guarantee all euro area debt. That of course is not the case in the real world. More importantly, however, these demands overlook the euro area's pooled sovereignty and lack of a centralized political authority. On matters of fiscal policy, the 17 national parliaments still have the final say in the euro area.

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