25 July 2013

Luigi Zingales: German banks on top

The Banking Union is not a scheme to burden German taxpayers with the losses of failed southern European banks, writes Zingales in this European Voice article. Rather, it is a mechanism to render all banks (including German ones) accountable for their own mistakes.

German banks have a lower cost of funding and – all else being equal – higher profitability. To the extent that some of the lower cost is rebated to their clients, even industrial firms in Germany enjoy a lower cost of capital, giving them an unfair advantage vis-à-vis their European competitors.

One way to prevent this distortion would be to create a mechanism to bail out all banks with European money. But this approach would not only leave German taxpayers on the hook; it would also create perverse incentives in the entire European banking system, maximising instability. The preferred alternative is to create a common resolution mechanism, which would apply throughout Europe, regardless of a bank's country of origin. Such a mechanism would prevent the need for government intervention.

The recent proposal by Michel Barnier, the European commissioner for the internal market and services, is an effort to implement this solution. It provides a common resolution mechanism for all banks in Europe, which forces losses to be absorbed by shareholders, bondholders, and large depositors before any government money is committed. To provide short-term financing to a bank during any restructuring, the Commission's plan would create a European Fund, putting all banks on an equal footing.

The Commission's proposal is far from perfect. After a bank's shareholders are wiped out and its creditors take an 8 per cent ‘haircut', the European Fund transforms itself into a bailout fund, justifying some of Germany's fears. And there is no explicit prohibition of some form of national government bail-out. Even so, the proposal is a step in the right direction. German criticism should be directed at improving it, not at sandbagging it.

German taxpayers have paid dearly for German banks' mistakes. In 2008, when the Landesbanken were found to be full of American sub-prime mortgages, the German government bailed them out with a €500 billion rescue package at its taxpayers' expense. In 2010, when German banks were badly over-exposed – to the tune of over €530 billion – to Greece, Ireland, Italy, Portugal, and Spain, European taxpayers and the ECB helped them to bring most of that money home. The biggest threat to German taxpayers is not southern European profligacy, but their own country's banks.

In this sense, the banking union is not a scheme to burden German taxpayers with the losses of failed southern European banks; rather, it is a mechanism to render all banks (including German ones) accountable for their own mistakes, thereby reducing the burden that they impose on domestic taxpayers.

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