By Daniel Gros
The doom-loop between banks and the national governments played a dominant role in the Eurozone crisis for Ireland and Cyprus. A Eurozone banking union is usually viewed as the solution. This column argues that the doom-loop cannot be undone as long as banks hold oversized amounts of their government’s debt. A simple solution would be to apply the general rule that banks are prohibited from holding more than a quarter of their capital in government bonds of any single sovereign.
The purpose of the proposed banking union is to de-link banks from their sovereigns.
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The doom-loop between banks and the national governments played a dominant role in the Eurozone crisis for Ireland and Cyprus. A Eurozone banking union is usually viewed as the solution. This column argues that the doom-loop cannot be undone as long as banks hold oversized amounts of their government’s debt. A simple solution would be to apply the general rule that banks are prohibited from holding more than a quarter of their capital in government bonds of any single sovereign.
The purpose of the proposed banking union is to de-link banks from their sovereigns.
- Putting the ECB in charge of supervision and creating a common resolution mechanism should help.
- European banks hold too much government debt of their own governments to really sever the sovereign-bank link.
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