At the time Europe is struggling to contain the COVID-19 pandemic, it is also preparing itself for another crisis – a financial crisis.
Although the unified currency of European countries has brought great benefits such as trade without barriers, improving global competitiveness, and others, the euro has also forced member states to abandon independent monetary policies that could help support national financial systems.
Europe is in financial crisis
With the COVID-19 pandemic crisis entering its second year in a row, distress in banks represents an increasing threat to the finances of individual governments – and vice versa – which is called the “doom loop“. The phenomenon appeared during the early 2010s, when the eurozone nearly disintegrated.
European leaders agreed in 2012 on what should have been a large part of the solution. They envisioned a complete banking union, where governments have a shared responsibility to supervise financial institutions, and the most important thing is to dismantle or recapitalize banks when necessary, and to safeguard depositors’ money.
Although the European Central Bank now oversees the largest banks in the region, individual governments still bear the cost of the slow progress bailouts.
The pandemic has exacerbated the problem, as governments take on more debt in their efforts to provide an economic bailout. The International Monetary Fund estimates that general government debt in the eurozone will exceed 98% of GDP by the end of 2021, up from 84% at the end of 2019.
Worse, the financial liabilities of individual countries are piling up in the balance sheets of their banks. At the end of February, Italian banks’ holdings of Italian government debt amounted to 124% of its capital and loss reserves, making it very vulnerable in the event of financial hardship.
These sovereign gaps make it difficult to achieve a banking union from a political point of view.
Northern countries such as Germany, for example, are unwilling to sign up to mutual deposit insurance if that means supporting Italian banks’ excessive holdings of Italian public debt.