More radical reform of EU banks needed

31/08/2011

“Urgent action is needed for Europe’s banking industry to remove the cloud of uncertainty hanging over banks and sovereigns,” International Monetary Fund (IMF) Managing Director Christine Lagarde said in Jackson Hole Wyoming last Saturday at an annual gathering of policymakers from around the world.

Following a time of severe losses for the banking industry across Europe, the former French Finance Minister proposed three ‘key steps’ which must be made in order to prevent ‘the fragile recovery’ from being ‘derailed’.

 
Firstly, sovereign finances must be sustainable. “If countries address long-term fiscal risks like rising pension costs or healthcare spending, they will have more space in the short run to support growth and jobs,” she said.

Secondly, and ‘key to cutting the chains of contagion’, is recapitalisation. The most efficient method of doing this, according to Lagarde, would be mandatory substantial recapitalisation - seeking private resources first, but using public funds if necessary.

 

“One option would be to mobilise European Financial Stability Facility (EFSF) or other European-wide funding to recapitalise banks directly, which would avoid placing even greater burdens on vulnerable sovereigns,” she said.

 

The third ‘key step’ to reform, according to Lagarde, is that ‘Europe needs a common vision for its future’.

 

“Europe must recommit credibly to a common vision, and it needs to be built on solid foundations, including, for example, fiscal rules that actually work,” she said. 
 

Lagarde is not the only person pushing for the reform of European banks.

 

French economist Jean-Luc Gréau, with his slogan ‘re-organise the banking system, make the lenders responsible’, also calls for a new European banking system. He proposes to:

 

  • Put the commercial banks under the supervision of central banks so that the two are interdependent, i.e. for commercial banks to lend, they must borrow from central banks. 
  • Separate bank deposits and bank loans, to protect depositors from being affected by the ‘bad loans’ of the bank.
  • Prohibit banks from speculating on their own account and making decisions based solely on their own financial results.
  • Restrict the geographic and economic intervention of the banks to prevent one country from becoming too affected by the ‘credit bubble’ of another.
  • Strictly supervise speculative practices by first setting a ‘minimum proportion of loans that issuers should keep in their accounts’.