Abstract
This study investigates the shock-absorbing properties of a banking union by providing a detailed comparison between the way regional financial shocks have been absorbed at the federal level in the United States, but have led to severe regional (national) financial dislocation and tensions in the euro area. The extent to which the institutions of the banking union, which is now emerging in the euro area, should increase its capacity to deal with future regional boom and bust cycles is also discussed. Cross-border capital flows in the form of equity appear to be much more stable than those taking the form of credit, especially inter-bank credit. Moreover, credit booms and bust leave a debt overhang and losses can materialise only via insolvencies, whereas equity flows absorb automatically losses in case of a bust and provide the cross-border owner with incentives to continue to provide financing even during a crisis. It follows that cross-border banks can absorb regional shocks. Of course, there is no free lunch: large cross-border banks pose the ‘too big to fail’ problem, and they also propagate shocks, especially if they originate in large countries, to the entire area.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
In that year a common mechanism and fund for both deposit insurance and resolution was created in the form of the FDIC (Federal Deposit Insurance Corporation). The creation of the FDIC came after most of the 50 different state-based deposit insurance schemes went bankrupt as a country-wide banking crisis led to the failure of hundreds of banks.
The starting point for this section is Gros (2012).
The initial loss estimates of the FDIC were later revised downwards to $2.4 billion. As some of the assets, which the FDIC had to value at crisis prices, later recovered partially. However, the initial estimate constitutes the more important figure because it shows the amount of risk the FDIC was prepared to assume at the height of the crisis. During a financial crisis the perception of risk by the market and the ability to bear risk is more important than the exact amount of the losses that materialise once the crisis is over. The loss estimates of Fannie and Freddy were not revised as they represent just the sum of mortgages that did not perform. At first sight it appears that the loss rate for the FDIC was about 10%, not much higher than the 8% of bail-in-able debt instruments that EU banks are supposed to hold under the regulations. This would seem to suggest that the likelihood that the SRM could face large losses should be minor. However, Washington Mutual, which had its headquarters in the state, represents a large part of the balance sheet of the intervened banks. However, given that there was no loss for the FDIC in this operation (WAMU was sold for 1 dollar) the loss rate on the other banks was much higher, about 30%.
Fannie Mae and Freddy Mac have taken the unusual step of indicating their credit losses for those states hardest hit by the crisis (including Nevada, Florida, California, for example).
The experience of Washington Mutual (WaMu) constitutes a somewhat special case. The biggest bank to have failed in US history, a mortgage specialist, WaMu had its headquarters in Nevada and some small operations there. However, its failure did not lead to any local losses as WaMu was seized by the FDIC and its banking operations were sold for a very low sum to another large US bank (JP Morgan Chase) – but without any loss for the FDIC. Such an ‘overnight’ operation would have been impossible in Europe where no euro area-wide institution would have carried through a cross-border takeover of this size. Moreover, WaMu received about $80 billion in low-cost financing from the US Federal Home Loan Bank. Irish banks received massive amounts of low-cost emergency liquidity assistance from the European Central Bank, but the Central Bank of Ireland had to guarantee these loans, which was not the case for the State of Nevada or for any bank in Nevada.
It appears, however, that the larger UK banks, like RBS, also had substantial operations in Ireland, where they had to write off of about 8 billion £. Unfortunately, it is not possible to establish what proportion of the write off resulted in actual losses and what part of any losses was incurred in the Republic of Ireland and what part in Northern Ireland.
See ‘Swedish banks can handle Baltic losses of 20 billion dollars’, http://www.baltic-course.com/eng/finances/?doc=14707zz; see also ‘Riksbank sees 2010 Baltic bank losses at USD 3.7 bln’, http://www.baltic-course.com/eng/finances/?doc=23185.
See Ingves (2010) and ‘SEB banka has not yet recovered what it lost during financial crisis’, http://www.baltic-course.com/eng/finances/?doc=88286.
For more detailed information see ‘FDIC Statistics at a glance’, http://www.fdic.gov/bank/statistical/stats/2012mar/fdic.html.
For an early discussion of fiscal and political union see Gros and Thygesen (1995). The view that a fiscal and political union is needed is expressed at the political level by the report of the four EU Presidents on Genuine Economic and Monetary Union. See van Rompuy et al. (2012).
Belke et al. (forthcoming) analyse the benefits and costs of a non-euro country opting-in to the banking union.
References
Advisory Scientific Committee (ASC). 2014: Is Europe Overbanked?, Reports of the Advisory Scientific Committee of the ESRB, No. 4/June 2014, https://www.esrb.europa.eu/pub/pdf/asc/Reports_ASC_4_1406.pdf.
Asdrubali, P, Sorensen, BE and Yosha, O. 1996: Channels of interstate risk sharing: United States 1963–1990. The Quarterly Journal of Economics. MIT Press 111(4): 1081–1110 November.
Athanasoulis, S and van Wincoop, E. 2001: Risk sharing within the United States: What do financial markets and fiscal federalism accomplish? Review of Economics and Statistics 83(4): 688–698 November.
Begg, I. 2014: Genuine economic and monetary union. In: Durlauf, SN and Blume, LE (eds). The new palgrave dictionary of economics, Online Edition.
Belke, A. 2013: Towards a genuine economic and monetary union – comments on a roadmap. Politics and Governance 1(1): 48–65.
Belke, A. 2013a: Debt Mutualisation in the Ongoing Eurozone Crisis – A Tale of the ‘North’ and the ‘South’, The New Palgrave Dictionary of Economics, Online Edition. In: Steven ND and Lawrence EB (eds). Palgrave Macmillan: Houndmills, Basingstoke.
Belke, A, Dobrzańska, A, Gros, D and Smaga, P. (forthcoming): (When) should a non-euro country join the banking union? Journal of Economic Asymmetries, in press.
Buch, CM, Körner, T and Weigert, B. 2013: Towards Deeper Financial Integration in Europe: What the Banking Union Can Contribute, Working Paper 02/2013, German Council of Economic Advisors, Wiesbaden, August.
De Groen, WP and Gros, D. 2015: Estimating the Bridge Financing Needs of the Single Resolution Fund: How expensive is it to resolve a bank?, CEPS Special Report No. 122, CEPS, Brussels, November, www.ceps.eu/publications/estimating-bridge-financing-needs-single-resolutionfund-how-expensive-it-resolve-bank. Also published on the European Parliament’s website, www.europarl.europa.eu/RegData/etudes/IDAN/2015/542687/IPOL_IDA(2015)542687_EN.pdf.
Demyank, Y, Ostergaard, C and Sorensen, B. 2007: Risk Sharing and Portfolio Allocation in EMU, European Commission Working Paper, Brussels.
Furceri, D and Zdzienicka, A. 2013: The Euro Area Crisis: Need for a Supranational Fiscal Risk Sharing Mechanism?, IMF Working Paper WP/13/198, International Monetary Fund, Washington DC, September.
Gros, D. 2012: Banking Union: Ireland vs. Nevada, an illustration of the importance of an integrated banking system’, CEPS Commentary, Centre for European Policy Studies, Brussels, October, http://www.ceps.eu/book/banking-union-ireland-vs-nevada-illustration-importance-integrated-banking-system.
Gros, D. 2016: A Fiscal Capacity for the Euro Area? What to Learn from the US Experience, Centre for European Policy Studies, Brussels, February, mimeo.
Gros, D and Thygesen, N. 1995: European Monetary Integration. Longman: London.
Hepp, R and von Hagen, J. 2013: Interstate risk-sharing in Germany: 1970–2006. Oxford Economic Papers 65(1): 1–24 January.
IMF. 2013a: A Banking Union for the Euro Area, IMF Staff Discussion Note 13/01, International Monetary Fund, Washington DC, February.
IMF. 2013b: Toward a Fiscal Union for the Euro Area, IMF Staff Discussion Note 13/09, International Monetary Fund, Washington DC, September.
Ingves, S. 2010: The Crisis in the Baltic – the Riksbank’s Measures, Assessments and Lessons Learned, Speech by Mr Stefan Ingves, Governor of the Sveriges Riskbank, to the Riksdag Committee on Finance, Stockholm, 2 February, http://www.bis.org/review/r100203b.pdf.
Kalemli-Ozcan, S, Papaioannou, E and Peydró, JL. 2010: What lies beneath the euro's effect on financial integration? Currency risk, legal harmonization, or trade? Journal of International Economics 81(1): 75–88.
Mink, M and de Haan, J. 2014: Spillovers from Systemic Bank Defaults, CESifo Working Paper 4792, Munich, May.
Pagano, M. 2014: Is Europe Overbanked?, Reports of the Advisory Scientific Committee, European Systemic Risk Board (ESRB), European System of Financial Supervision, No. 4, June, Frankfurt/Main.
Van Rompuy, H in close collaboration withBarroso, JM, Juncker, J-C and Draghi, M. 2012: Towards a Genuine Economic and Monetary Union, http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/134069.pdf.
Acknowledgements
The authors are grateful to Matthias Busse for valuable research assistance and to an anonymous referee for valuable comments. They also gratefully acknowledge comments received by participants at the International Finance and Banking (FIBA) Conference, 26–27 March 2015, Bucharest, Romania, where this paper was presented as a keynote lecture.
Author information
Authors and Affiliations
Corresponding author
Additional information
This symposium paper is based on a keynote address given at the XIIIth edition of the International Finance and Banking (FIBA) Conference organized by the Faculty of Finance of the Bucharest School of Economic Studies which was held on March 26–27, 2015 in Bucharest, Romania.
Rights and permissions
About this article
Cite this article
Belke, A., Gros, D. On the Shock-Absorbing Properties of a Banking Union: Europe Compared with the United States. Comp Econ Stud 58, 359–386 (2016). https://doi.org/10.1057/ces.2016.9
Published:
Issue Date:
DOI: https://doi.org/10.1057/ces.2016.9