Economics, International economy

Will Europe fix its banks in time?

Image Credit: MPD01605 (Flickr) CC

Image Credit: MPD01605 (Flickr) CC

One has to welcome the European Central Bank’s initiative to conduct a thorough stress test on Europe’s 130 major banks as part of its effort to ensure that the European banks become adequately recapitalized. However, given that this stress test will only be completed by end-2014, one has to wonder whether more needs to be done in the interim to get bank credit flowing again in the European periphery. For, without the resumption in bank lending to the periphery, it is difficult to see how one gets a meaningful European economic recovery in 2014.

More troubling yet, one has to be concerned about the potential damage that could be done to European bank lending by Germany’s insistence that any further government assistance to the banks must be accompanied by the bailing-in of the banks’ junior and senior bond holders. Especially in light of the recent experience with the Cypriot bank restructuring, one would think that there is a real risk that European banks will have funding problems ahead of any official recapitalization exercise. Given how dependent many European banks are on non-deposit funding, one would think that troubles in the wholesale market could further constrain their lending activities.

The need for the Europeans to address their banking problem more expeditiously and in a better thought out manner is underlined by the fact that, unlike in the United States, European banks are still responsible for around 80% of lending to their corporate sector. It is also underlined by the fact that there is no sign to date of any slowing in the pace at which banks are cutting back on credit in the periphery. The latest data indicate that over the past 12 months, bank credit has been cut by around 3% in Italy and around 6% in Spain. Absent an early end to credit crunch in the European periphery, it is difficult to see the basis for a strong European recovery. This is particularly the case when one considers that the credit crunch is occurring at the same time that many countries in the European periphery still have to implement budget austerity measures.

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