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More power to the ECB now!

, by Peter Claeys

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The financial crisis that started about one year ago has taken some time to spread, both across the financial industry and across the globe. The isolated problems in some US and UK banks have over the last weeks spread out.

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It first accelerated as the banking industry in the US melt down (leading to a nearly complete nationalisation of the banking sector). Now, it also starts to affect European banks.

Several EU governments have started to buy up shares in banks. The Benelux governments supported Fortis, France the Dexia bank, Ireland guaranteed deposits on the main six banks in the country, Germany kept track of the books of a Bavarian bank, and the UK nationalised Northern Rock some time ago.

Despite monetary unification, the current rules of the game are set out by national governments

Despite monetary unification, the current rules of the game are set out by national governments. The supervision role of central banks has remained under the authority of national level. Moreover, in case of financial problems in a bank, it is not the ECB, but the national government that will need to save the bank. Many studies, dating from long before the financial crisis today, have forewarned of the dangers that this fragmentation of regulatory policies and the lender of last resort function carries for the EU economies.

In the short term, national governments that try to save banks located in their country are bound to overlook the effects of their action on the other EU member states. Not only are banks more and more international (e.g. look at the Dutch-Belgian Fortis, or the French-Belgian Dexia). Even national banks are ever more closely related to each other on financial markets. National policies that look only at the national books of a bank cannot assess all the effects of bailing out the bank. The danger of contagion remains, and the crisis cannot be stemmed, as the commitment of national governments to bail out is not sufficient for markets to believe that all problems have been solved.

Ignoring this spillover effect raises the risks of a larger and deeper financial crisis. Eventually, the cost for taxpayers of a non-coordinated action is likely to be much higher.

In the long term, the nationalisation of banks is going to corroborate the fragmentation of the European banking system. Much of the benefits of financial integration, in terms of insurance, economic growth, etc. will be hampered by the (re)nationalisation of banking champions.

It is therefore crucial that national governments sit together and coordinate their responses, developing Europe-wide solutions where appropriate. Speeding up the response to global crises is a task that should be preferably placed in the hands of the European Central Bank.

A combination of monetary policy, together with the EU wide monitoring of EMU banks, would be particularly welcome to stem. At present, it might avoid that unexpected events in one EU country lead to a “cascade of failures and panics”. In the future, ECB monitoring might avoid crises before they even occur, and preferably without involving the deep pockets of fiscal policy.

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Image: European Central Bank; source: www.flickr.com

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