Jun 26, 2009 | 19:03 GMT

5 mins read

EU: The Challenges of a Bank Bailout

The European Central Bank (ECB) has loaned some 442 billion euro (about $622 billion) in 1 percent, one-year loans to Europe's banks in an effort to keep the Continent's troubled banking system afloat. In its efforts to rescue Europe's banks, the ECB has been hobbled by a lack of oversight powers. The absence of these powers may mean that this infusion represents the sum total of Europe's bank bailout.
In anticipation of a rash of banking failures in Europe's future, The European Central Bank (ECB) on June 24 opened up an unlimited supply of 1 percent, one-year loans to European banks as a means of keeping damaged banks afloat. The ECB reasoned that if banks are flush with cheap cash, then they should not need to worry about the normal problems that can cause banks to fail — bank runs, not meeting reserve requirements, too many nonperforming loans, etc. — for at least the next year. All told, the ECB loaned some 442 billion euro (about $622 billion), doubling in a single day the amount of liquidity it has given the European banking system. This week's infusion of credit is welcome considering that the ECB's June 2009 Financial Stability Review estimated that European banks will be forced to accept losses on an additional $283 billion in bad assets due to the default by U.S. and EU consumers on mortgages and other loans. Given the estimated $649 billion in bad assets for the entire financial crisis in Europe, this estimate may paint too rosy a picture of the European banking sector. The International Monetary Fund (IMF) puts the total at $904 billion, which means there could be more than $500 billion in write-downs still to come. Interestingly, the 442 billion euro of loans just about fits IMF estimates of future bank losses in Europe, and although the ECB has called the IMF estimate into question, the market appears to have lent a great deal of credence to it. Most notable about the ECB's decision to open the gates, however, is that it has happened in a vacuum. Europe's banking troubles are legion. European countries all face disparate banking problems. For one set of countries (Spain and Ireland in particular), adopting the euro led to increased borrowing as consumers and businesses rushed to profit from low interest rates that came with the euro. Meanwhile, other eurozone countries (Italy, Greece and Austria in particular) rushed into the emerging markets of Central Europe, offering those same euro loans via bank subsidiaries that set up shop across the region. Both cases brought on a capital explosion that is now threatening to reverse itself, leaving in its wake a disastrous number of nonperforming loans across the board. This, plus the harsh recession going on in Europe, threaten banks across the Continent. In the United States, such a mix of problems would require the joint efforts of the Treasury Department (which sets regulatory policy), the Federal Deposit Insurance Corp. (FDIC; which establishes and enforces fail-safe mechanisms for banks) and the Federal Reserve System (which enforces regulatory policy and controls the money supply). Some of the methods that these U.S. institutions have used have included raising bank reserves, swapping out toxic assets, setting up a loan restitution program, adding capital directly to banks, raising transaction and deposit insurance levels, or taking particularly damaged institutions into direct receivership. But none of these institutions have equivalents in Europe, so none of these options exist. There is no overall "European" treasury or FDIC equivalent at all. Instead, responsibility for bank regulation is a national prerogative that explicitly falls outside the ECB's charter. The ECB itself does have some responsibilities similar to those of the Fed, but only in terms of managing money supply, and even then only for the 16 EU states that actually use the euro. Bereft of any institutional proxies or allies, the ECB is doing the best it can with the tools it has available, and so has provided as much credit to European banks as they want for a year. But the ECB lacks the authority even to force the banks to use the credit in ways that would fight the recession, such as using the money to grant new loans. It is clear that many European banks simply plan to sit on the cash in case of emergencies. Within 24 hours of the ECB's low-credit splurge, more than a third of the money — some 143 billion euro (about $201 billion) — had been deposited back at the ECB in the various banks' overnight accounts. By comparison, on June 24 banks deposited only 7.4 billion euro (about $10 billion.) Without any follow-on regulation — regulation that the ECB is powerless to draft, implement or enforce — there is little reason to expect the ECB's actions to do more than buy some time. Ultimately, the point is that were Pan-European banking regulation easy to agree on, the 27 EU member states would have done so by now. Though the global recession hit nine months ago, Europe's recession had begun six months before that. Since then, national efforts to repair Europe's banks have been fair to middling — meaning the ECB's credit extension may well represent Europe's entire bank bailout.

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