Lessons from the European Financial Crisis

CFS Working Paper No. 486

31 Pages Posted: 1 Nov 2014

See all articles by Marco Pagano

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Research Institute of Industrial Economics (IFN); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: September 8, 2014

Abstract

This paper distils three lessons for bank regulation from the experience of the 2009-12 euro-area financial crisis. First, it highlights the key role that sovereign debt exposures of banks have played in the feedback loop between bank and fiscal distress, and inquires how the regulation of banks’ sovereign exposures in the euro area should be changed to mitigate this feedback loop in the future. Second, it explores the relationship between the forbearance of non-performing loans by European banks and the tendency of EU regulators to rescue rather than resolving distressed banks, and asks to what extent the new regulatory framework of the euro-area “banking union” can be expected to mitigate excessive forbearance and facilitate resolution of insolvent banks. Finally, the paper highlights that capital requirements based on the ratio of Tier-1 capital to banks’ risk-weighted assets were massively gamed by large banks, which engaged in various forms of regulatory arbitrage to minimize their capital charges while expanding leverage. This argues in favor of relying on a set of simpler and more robust indicators to determine banks’ capital shortfall, such as book and market leverage ratios.

Keywords: bank regulation, euro, financial crisis, sovereign exposures, forbearance, bank resolution, bank capital requirements

JEL Classification: G01, G21, G28, G33

Suggested Citation

Pagano, Marco, Lessons from the European Financial Crisis (September 8, 2014). CFS Working Paper No. 486. Available at SSRN: https://ssrn.com/abstract=2517318 or http://dx.doi.org/10.2139/ssrn.2517318

Marco Pagano (Contact Author)

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