by Don Alexander, MBA
Associate, RSD Solutions Inc.
A recent paper “The Eurozone debt crisis: Is this a banking problem? (VOXEU, Jordi Gual, September 13th”) provides a valuable lesson for risk management. In this case, it is the focus on the consequences and not the cause of risk.
The IMF recently suggested that recapitalization of Europe’s banks as the most prudent way out of the continent’s economic crisis. Gual argues that such thinking is based on a flawed analysis and at best it serves as a distraction to policymakers. The primary problem facing Europe is a sovereign debt crisis.
The call for a recapitalization of the banking system is a distraction and if the sovereign debt crisis was resolved, the banks would not be in trouble. According to the Institute of International Finance (IIF), European banks raised $414 billion in new capital since 2008 compared to their American counterparts which raised $314 billion in the same period. The perception problem is that European banks hold more of their assets in public debt than their American counterparts.
One by product of the euro is the pricing of most private and public sector debt at eurozone reference rates. This has resulted in a mispricing of eurozone risk, poor investment choices and a misallocation of capital. The current proposal of bank recapitalization arises from the potential losses from mark-to-market of government debt. The idea is that investors should suffer from the poor investment decisions made by the banks despite having a potential economic cost (credit availability).
The real problem is that Europe has built a monetary union with an inherent flaw – the absence of a sovereign safety net, since the debts are accumulated by member states have been incurred in a currency that none control. This is the issue, and not bank recapitalization.
Have you correctly identified your source of risk?
For more on this follow the link: http://www.voxeu.org/index.php?q=node/6970
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