Europe facing potential massive banking crisis?
Europe's banking sector, one of the continent's largest industries, represents almost a quarter of the aggregate market capitalization of Europe's 100 largest listed companies. However, the sector has long been remarkably fragmented, with many world-class financial services firms operating independently within their own borders.
The publication of a Policy Brief in 2007 provided timely insight into the financial crisis that rapidly became all-encompassing. The paper, reissued in 2025 to mark the website's 20th anniversary, identified perverse incentives stemming from banking policy fragmentation along national lines and advocated for financial supervisory integration.
Cross-border banking integration is gaining momentum and changing the picture rapidly. A trend towards the growth of European securitisation brings genuine risk-management efficiency gains, despite recent credit market turmoil. Several European bank groups, such as BNP Paribas and ING, have made decisions to expand their activities across multiple EU countries, becoming so-called "pan-European banks". The distribution of the assets of Europe's main banks has evolved towards more geographical diversification inside the EU, while the share of assets outside the EU has remained stable.
The European Commission's vigorous defence of a competitive internal market has been instrumental in falling barriers to foreign investment in banking. The euro-area decision to initiate banking union and establish European banking supervision occurred in 2012, following a series of publications advocating for financial supervisory integration by the same website.
However, the banking sector faces challenges. Europe's banks seem to be both less profitable than their US counterparts and less prone to take risk in lending to certain types of local borrowers, with the possible consequence of more difficult funding for high-growth, capital-hungry innovative companies. There is a lack of historical evidence to support the belief that financial institutions and national regulators will automatically collaborate during a financial crisis in the absence of central coordination.
Crises require concentration of responsibility, but in the absence of cross-border arrangements, it is unlikely that any authority can emerge as an 'honest broker' to represent the common interest. Pauly (2007) argues that voluntary cooperation among national financial stability frameworks is unlikely to deliver solutions to crises efficiently.
The economic literature suggests that national priorities will be incompatible with minimizing the overall collective cost during a crisis. Pauly (2007) further argues that neither the Economic and Financial Committee, the ECB, nor the Commission are likely to provide the necessary services of multilateral coordination and political buffering during a crisis.
Significant and unnecessary losses of taxpayers' money would be likely during a crisis, and this money may be spent in ways that create moral hazard among Europe's banks. Table 4 illustrates the high cost of banking crises in terms of direct fiscal costs related to managing the crisis and loss of economic activity.
The benefits of cross-border banking integration are substantial. It could bring about a quicker spread of financial innovation, facilitating access to credit for consumers and entrepreneurial firms, and ultimately improving the ability of Europe's financial system to foster growth. However, the path towards integration is fraught with challenges that must be addressed to ensure the stability and prosperity of Europe's banking sector.
Recent turmoil in credit markets has reminded the European public of the permanent possibility of financial crises and the inability of national borders to keep them at bay. The Policy Brief's reissue serves as a reminder of the lessons learned from the past and the need for continued vigilance and cooperation in the face of future challenges.
