Seamus Coffey has an excellent article on resolving the euro zone banking crisis in today’s Irish Independent (HT DOCM). For the Irish situation, Seamus puts the proper focus back on the case for extending the maturity of the promissory notes/ELA arrangements as the correct focus of negotiations. The idea that the ESM would retrospectively cover already crystallised losses in the Irish banking system looks fanciful, and only serves to create confusion about what Ireland needs – and could realistically be provided – in order to further the shared objective of getting Ireland off external assistance.
In the certainty of attracting vitriol in comments, I think Seamus is being a bit hard on the ECB. The problem that the ECB faces is a bank creditworthiness crisis across a significant part of the euro zone. In fairness, they have been willing to meet their proper function of acting aggressively as a lender of last resort to stem deposit flight. But they can only do this if the banks they are lending to are solvent. They have insisted that the banks be recapitalised, preferably directly from centralised bailout funds, but failing that by governments, with money borrowed from those funds.
I think most analysts agree that the future stability of the euro zone will require a form of banking union, with centralised supervision, centralised deposit insurance and a centralised resolution regime that allows for losses to be imposed more broadly on certain classes of bank creditors. The challenge is how to get from here to there. In the short term, putting creditors at greater risk of losses reduces bank creditworthiness further, potentially causing the crisis to escalate. Moreover, given the differences in the solvency of the banks in different euro zone countries, any move towards centralised deposit insurance has potentially large distributional implications across euro zone countries. If a deposit insurance regime could be agreed behind a “veil of ignorance”, with negotiators not knowing which country they represented, it should be relatively easy to agree to such arrangements. But alas this “ignorance” is not available. The messy and fragile two-way process involving greater risk sharing and more credible assurances of mutual discipline will continue.