Many observers have appreciated the Irish response to the crisis

The debt crisis in some member states of the European Monetary Union shows once more how closely related bank crises and sovereign debt crises are.

However, the details of the crises in the various countries are quite different. In Ireland, the consequences of a bursting bubble on financial and real estate markets are the main problem. Many observers have appreciated the Irish response to the crisis.

The Irish economy seems to be competitive, as the almost balanced current account shows. However, important problems remain. Firstly, risks and losses are carried by the taxpayer and not by those who benefited most from the previous boom, the share holders and owners of banks. This distorts incentives for future risk awareness.

Secondly, the spending cuts and tax increases that are necessary to stabilise public debt slow down the recovery of the economy.

This is delicate because the rescue measures for the banking system have not discriminated between domestic and foreign depositors, also due to corresponding European law. Therefore, the Irish measures reduced to some extent the need for financial aid in other countries.

Accordingly, it seems plausible to share follow- up costs with other countries. This could be done by direct transfers of a European institution to banks within a banking union.

And indeed, acknowledging the increasing integration of the financial system in the EU in the past decade, the decoupling of national banking crises from national public debt is a logical consequence. However, like any other insurance, the insurance component of a European banking union should not cover existing damages.

Furthermore, direct transfers to banks or deposit holders should only be implemented, if the central regulatory institution is also explicitly entitled to restructure or close banks.

The Japanese experience shows that it is very important not to keep zombie banks alive. Ireland would surely benefit from a European banking union. However, the banking union is not a vehicle for sharing the costs of past decisions. It is a vehicle for a more efficient banking regulation in the future.

If its introduction fails due to discussions about the distribution of follow-up costs of the current crisis, everybody will be worse off.

* Oliver Holtemöller is professor of economics at Martin Luther University, Halle-Wittenberg. Tobias Knedlik is an economist at the Halle Institute for Economic Research


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