His October analysis argues that the banking crisis in Europe is the result of undercapitalisation of banks in major money centres, rendering them vulnerable to the smallest fluctuations in the market. Liquidity problems thus quickly become solvency problems, which leads to a lack of trust between banks and "paralyses the inter-bank market," it explains.
Gros therefore suggests a two-pronged approach whereby each EU member state would re-capitalise its large banks and guarantee the reimbursement of national banks' inter-bank loans, including cross-border loans to other EU banks.
The UK has already taken steps to this direction, while others are likely to follow, Gros predicts. Most importantly, the response will have to be coordinated, as the problem cannot be solved by the UK alone and a larger number of participating countries will strengthen the impact of any action, he adds.
Anticipating potential objections from finance ministers about "unacceptable risk," Gros argues that the risk is in fact fairly limited. Governments have already announced that they will bail out their own large banks, therefore implicitly guaranteeing their liabilities, he writes.
Gros concludes that in the absence of massive losses from housing-related activities, "the key issue in Europe" is essentially resolving the coordination problem. He thus urges the major European governments to "agree rapidly on such a scheme to get at least the euro-area inter-bank market moving again".
