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S. Micossi: Eurozone Stability still under the Threat of a “Bad Shock”

image-07/21/2016 - 11:08On 25 June, VoxEU published "Making the Eurozone more resilient: What is needed now and what can wait," an article supported by an impressive list of 'Resiliency Authors' (RA). It argues that the Eurozone now has an adequate financial architecture for coping with another "bad shock" and that what needs to be done "mostly [is] to make sure that the rules in place can be enforced." I feel that this view may prove optimistic and, more importantly, that careless implementation of existing rules may become the very source of a new bad shock. Let me explain why.

The RA share the view that the Eurozone has not resolved the problem of risk-sharing that lay at the root of the sovereign debt crisis of 2010-12; they recognize that the European Stability Mechanism (ESM) is too small to provide sufficient resources in the event of a shock hitting the sovereign debt of a large country such as Italy and that its decision-making procedures would not ensure the prompt action needed to stop a financial market rout. They also observe that the Single Resolution Fund (SRF) may prove too small to confront a major shock hitting a large cross-border bank or an important segment of a national banking system, but they maintain that, if necessary, the ESM would be allowed to step in. Furthermore, they consider the lack of cross-border deposit insurance, the as yet unrealized European Deposit Insurance Scheme (EDIS), as something to be fixed over time, but not an urgent problem. In sum, the glass, in their view, is half-full, and they insist that what we have is sufficient for ruling out a new bad shock.

I would rather see the glass as half-empty. I fear that the combination of extensive economic and financial fragility in some member states and large segments of the banking system, on one hand, and an incomplete institutional set up on the other, create sufficient opportunities and incentives for financial investors to test the system's resiliency; they may only be waiting for some trigger to coordinate expectations, before launching an attack (and the aftershocks of Brexit could very well provide that trigger). Should this happen, a new bad shock similar to the one in 2010-2011 could occur. 

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