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Strong Governments, Weak Banks

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  • De Grauwe, Paul
  • Ji, Yuemei

Abstract

Banks in the northern eurozone have capital ratios that are, on average, less than half of the capital ratios of banks in the eurozone�s periphery. The authors explain this by the fact that northern eurozone banks profit from the financial solidity of their governments and follow business strategies aimed at issuing too much subsidised debt. In doing so, they weaken their balance sheets and become more fragile � less able to withstand future shocks. Paradoxically, financially strong governments breed fragile banks. The opposite occurs in countries with financially weak governments. In these countries banks are forced to strengthen themselves because they are unable to rely on their governments. As a result they have significantly more capital and reserves than banks in the northern eurozone. Recommendations More than in the south, the governments of northern Europe should stand up and force the banks to issue more equity. This should go much further than what is foreseen in the Basel III accord. If the experience of the southern eurozone countries is any guide, banks in the north of the eurozone should at least double the capital and the reserves as a percentage of their balance sheets. Failure to do so risks destroying the financial solidity of the northern European governments when, in the future, negative shocks force these governments to come to the rescue of their undercapitalised banks. The new responsibilities entrusted to the European Central Bank as the single supervisor in the eurozone create a unique opportunity for that institution to change the regulatory and supervisory culture in the eurozone � one that has allowed the large banks to continue living dangerously, with insufficient capital.

Suggested Citation

  • De Grauwe, Paul & Ji, Yuemei, 2013. "Strong Governments, Weak Banks," CEPS Papers 8646, Centre for European Policy Studies.
  • Handle: RePEc:eps:cepswp:8646
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    File URL: http://www.ceps.eu/system/files/PB305%20PDG%20%2526%20YJ%20Strong%20Govts%20Weak%20Banks%20final.pdf
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    Cited by:

    1. Diego Valiante, 2015. "Banking union in a single currency area: evidence on financial fragmentation," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 7(3), pages 251-274, August.
    2. Aitor Erce, 2015. "Bank and sovereign risk feedback loops," Globalization Institute Working Papers 227, Federal Reserve Bank of Dallas.
    3. Rachel A. Epstein & Martin Rhodes, 2014. "Banking Nationalism on the Road to Banking Union," KFG Working Papers p0061, Free University Berlin.

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