The forgotten part of the Brexit debate: the Eurozone

Amid all the debate about the EU, we seem to have forgotten that the European financial system is far from fixed

Saturday 30 July 2016 17:19
Graffiti art displaying the European Union (EU) flag and a euro symbol
Graffiti art displaying the European Union (EU) flag and a euro symbol

One of the more curious aspects of the recent debate about Brexit is the extent to which the best part of almost a decade's worth of incessant and violent eurozone crises, usually driven by busted banks or governments, have been forgotten. The latest official "stress tests" of the financial robustness of leading banks across the EU are a timely reminder that the European financial system is far from fixed. Predictably, the Italian banks did badly, but so too did the Royal Bank of Scotland, including NatWest, majority owned by the British public.

True, Britain was never part of the eurozone, which, with a few others, gave this country an invaluable flexibility and insulation from the various bailouts. The insolvency of Greece and Cyprus, despite the blanket coverage, also had little direct impact on the British taxpayer or financial system. Still, the single currency remains the biggest single fact of economic life in our largest trading partner, and it has been at times close to break-up. In or out of the eurozone, and in or out of the EU, it matters.

The tests the European Banking Authority set for the biggest banks in the EU were extreme, and that was the point. No one needs to know how banks will fare in the good times. The weaker brethren were predictable, with the stand-out (theoretical) failure the world's oldest bank, the Italian Monte dei Paschi. This one has been lending money since 1472, but perhaps not for much longer as an independent entity. The Italian government will need to recapitalise it one way or another, with the added complication that the bank has a number of private bondholders whose position (in contrast to conventional savers with a deposit account) is vulnerable. Given that the Italian banks have traditionally been the main buyer of Italian government debt, their health is a crucial factor in the ability of the government of the eurozone's third largest economy to keep functioning. That really is a big deal.

The long-held fear among Europe's elite is that either Spain or Italy would end up in the same dire state as Greece, and require emergency aid from Germany to keep going. The problem with Spain and Italy is that they are so much larger than Greece it would be difficult even for Chancellor Merkel to find the funds to avoid a massive default and banking collapse in either, and certainly not simultaneously in both. The latest stress testing of some major institutions such as the Spanish Bank Popular and the Italian Unicredit suggest there is still ground for concern, even if this was a hypothetical exercise.

Not that the British can feel smug. The RBS Group and Barclays both performed less well than might have been hoped after years of tapping shareholders for extra reserves. For this country, Brexit means that any of the usual economic risks to the banks are magnified by the arrival of such huge uncertainties about the UK's economic future. And, while private investment has stalled, we also find major public projects such as Hinkley Point, Heathrow expansion and HS2 paused or running into difficulties. This is bad for the wider economy. A drop in investment means lower growth immediately and the danger of tipping the economy into a tailspin. In the longer run it means lower productivity and lower living standards. Confidence needs to be restored.

The Bank of England meets this week to judge its latest move. A radical loosening of monetary policy through lower interest rates, an expansion of quantitative easing and targeted credit easing for investment are the least the economy requires to be returned to growth consistent with the Bank's inflation target. Now is the moment for Governor Mark Carney to be bold and to be seen to be bold.

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