Strong Governments, Weak Banks

CEPS Policy Briefs No. 305

7 Pages Posted: 28 Nov 2013

See all articles by Paul De Grauwe

Paul De Grauwe

London School of Economics & Political Science (LSE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Centre for Economic Policy Research (CEPR)

Yuemei Ji

KU Leuven - Faculty of Business and Economics (FEB)

Date Written: November 25, 2013

Abstract

Banks in the northern eurozone have capital ratios that are, on average, less than half of the capital ratios of banks in the eurozone’s periphery. The authors explain this by the fact that northern eurozone banks profit from the financial solidity of their governments and follow business strategies aimed at issuing too much subsidised debt. In doing so, they weaken their balance sheets and become more fragile – less able to withstand future shocks. Paradoxically, financially strong governments breed fragile banks. The opposite occurs in countries with financially weak governments. In these countries banks are forced to strengthen themselves because they are unable to rely on their governments. As a result they have significantly more capital and reserves than banks in the northern eurozone.

Recommendations

More than in the south, the governments of northern Europe should stand up and force the banks to issue more equity. This should go much further than what is foreseen in the Basel III accord. If the experience of the southern eurozone countries is any guide, banks in the north of the eurozone should at least double the capital and the reserves as a percentage of their balance sheets. Failure to do so risks destroying the financial solidity of the northern European governments when, in the future, negative shocks force these governments to come to the rescue of their undercapitalised banks.

The new responsibilities entrusted to the European Central Bank as the single supervisor in the eurozone create a unique opportunity for that institution to change the regulatory and supervisory culture in the eurozone – one that has allowed the large banks to continue living dangerously, with insufficient capital.

Keywords: eurozone, governments, banks, northern Europe, Basel III accord

Suggested Citation

De Grauwe, Paul and Ji, Yuemei, Strong Governments, Weak Banks (November 25, 2013). CEPS Policy Briefs No. 305, Available at SSRN: https://ssrn.com/abstract=2360476

Paul De Grauwe (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Yuemei Ji

KU Leuven - Faculty of Business and Economics (FEB) ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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