Banking sector’s contribution to growth ‘nil or negative’, EU advisors say

Flying the flags. Frankfurt Borse, June 2007. [Marcelo Tourne/Flickr]

Europe’s banking sector is bloated and takes at least as much out of the economy as it adds, academic advisers to Europe’s early warning financial risk body said in a report published on Monday.

“According to all indicators, our patient is abnormally heavy”, the academics wrote in the 50-page report, entitled “Is Europe Overbanked?“, in which they set out a suite of policy options to shape up the sector.

The academics, whose suggestions included increasing minimum capital requirements, wrote the report for the European Systemic Risk Board (ESRB) – a body designed to give early warnings and one of Europe’s flagship responses to the financial crisis.

“The European banking system has reached a size where its marginal contribution to real economic growth is likely to be nil or negative,” the academics, led by Marco Pagano, wrote in the report.

The ESRB is hosted and supported by the European Central Bank, though the ECB and the new single supervisory mechanism (SSM) – Europe’s banking supervisor – are not obliged to comply with any recommendations it makes.

The SSM, run separately out of the ECB, is due to take over supervision of euro zone banks in November after conducting a health check of the sector.

The academics wrote that Europe’s banking sector was associated with imbalances such as over-investment in housing and diversion of talent from non-financial sectors.

An increasing bias in Europe’s financing structure over the last 15 years towards banking and away from securities markets had bucked the global trend.

“This is a matter of concern because financial structures heavily skewed towards banking are associated with lower economic growth,” they wrote in the report for the ESRB.

They added that the universal banking model – whereby banks perform a wide range of banking services – was widespread across Europe, presenting a source of fragility as it is associated with higher levels of systemic risk exposure.

To address deficiencies in the sector, the academics said the European Union could increase minimum capital requirements to boost the resilience of banks. Switzerland requires its banks to hold more capital than international standards demand.

Other policies recommended include:

  • To curb excessive debt accumulation, EU member states could remove the preferential fiscal treatment of debt.
  • To control the size of large banks, the EU could implement more aggressive antitrust policy.
  • To develop non-bank credit supply, the EU could encourage intermediation by non-banks.
  • Competent authorities could increase the risk weights applied to intra-financial system exposures, or reduce large exposure limits among financials.

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