Europe must change course on banks
Thursday 22 December 2011 - by Nicolas Véron
The eurozone crisis keeps evolving along multiple dimensions. On the sovereign debt front, no deal is yet in sight on Greece's debt restructuring, and Italy and Spain face major refinancing needs in early 2012.
The result is fragmentation: whether a euro held in a Greek bank is equivalent to a euro in a German bank is ever more in doubt. This could produce a slow-moving death spiral for a currency union.
Instead of fighting this trend, the recapitalisation plan agreed on October 27 has reinforced it. More guarantees on banks are introduced at the national level, none at the European one.
Moreover, when raising the minimum capital ratio to 9 per cent, leaders decided that its assessment would rest on fair value (or mark-to-market) measurement of each bank's portfolio of sovereign debt.
The fair value principle is sound for financial disclosure purposes. But it is dangerously pro-cyclical when applied to regulatory capital calculations, especially when extended to debt that is held to maturity - a radical move towards "full fair value" that accounting standard-setters have never dared to embrace. This is a recipe for massive credit rationing and misallocation, for which there is more and more anecdotal evidence.
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