Ben Chu: A banking union will not be enough. We need growth

Does the road to eurozone salvation pass through a European banking union? Policymakers increasingly seem to think so. The European Commission pushed clearly in that direction yesterday. The president of the European Central Bank, Mario Draghi, has said such a union is necessary. And the proposal will be under discussion by leaders at the Brussels summit later this month.

That's encouraging, since it suggests that the euro cent is finally dropping for Europe's leaders. It has dawned on them that not all of Europe's problems can be solved by spending cuts and tax rises. Ireland's massive sovereign debt pile is not a consequence of irresponsible government spending – as some in Germany have bone-headedly insisted – but the result of bailing out a gigantic domestic banking sector that went berserk in the boom years. Similarly in Spain, a collapsing private banking sector pumped up an enormous construction bubble and now threatens to capsize a government that was actually fiscally conservative.

There are two deadly feedback loops that result from weakened banking sectors. First, institutions, nursing big unrecognised losses from bad loans, are cutting off credit flows to sound European companies, helping to push economies into recession. Second, nervous depositors are accelerating the crisis by withdrawing money from banks in the periphery out of fear that they might not get their savings back, or that their money could end up converted overnight into new drachmas, punts, escudos or pesetas.

If Europe could agree to clean up the Continent's banks – by recapitalising them from a central European bailout fund and guaranteeing that ordinary depositors will always be paid back in euros – they would take the pressure off struggling governments, reducing the risk of a eurozone breakup.

While a banking union would be a necessary condition, it would not be sufficient. For that, the struggling nations of the periphery also need to see some hope of growth. And quickly.