Another solution would be to only allow narrow banking, so that all money in checking accounts needs to be backed by money (electronic reserves). If banks want to invest in other securities, like sovereign bonds, they would have to sell other instruments, for instance bond ETFs.
Could someone explain why Italian banks hold so many Italian govt bonds? What prevents them from holding a diversified portfolio including German or Dutch govt bonds - same credit rating, no currency risk?
There are several reasons. Sometimes there is "moral suasion" which means basically the government asks them to do it. But the main one to me is this: the interest rate is higher, and the bank thinks: "if Italy fails, I am toast anyway, so I am not really increasing my risk by loading up on that scenario".
Do you think there is political will for a true Fiscal Union and Banking Union, or does the EU 'need' a new crisis, in other words for it to become 'Europe's problem' to act?
I am afraid we need another crisis-- there is no movement on the Fiscal front. And we probably will not be able to move all together, as the interests are not going to fully aligned. I could see for instance the Northern Europe military vulnerability incrasing (e.g. Trump/NATO) and the Nordics and some others giving a large step forward.
Sadly. It does not. As long as deposit insurance is a national responsibility, and banks are as loaded up on sovereign loans as I described, the risk persists.
having just wrote my Thesis about TPI and how it relates to the current Toolbox the Eck has at its disposal, I think the conclusion you are drawing is wrong. There would be limited incentives for Non-Italian Banks to buy Italian bonds and there would be even less Pressure for Italy to properly tax its property wealth in Order to finally fix their Budget. What you suggested in Cochrane et al (which I funnily draw upon in my thesis) seems a lot better. Create a proper default mechanism/Procedure, which is known to market participants and which is a credible threat, keeping at least partial market disciplin functioning.
Hi Adrian. Both a deposit insurance/conclusion of the banking union and the drastic reduction of sovereign bank exposures are very much part of our proposals, as well as the default mechanism. They all go together.
Another solution would be to only allow narrow banking, so that all money in checking accounts needs to be backed by money (electronic reserves). If banks want to invest in other securities, like sovereign bonds, they would have to sell other instruments, for instance bond ETFs.
And the ECB could issue reserves backed by a basket of consumption-linked perpetuities, see here: https://gideonmagnus.medium.com/the-case-for-consumption-linked-perpetuities-in-the-eurozone-557779ece710
Could someone explain why Italian banks hold so many Italian govt bonds? What prevents them from holding a diversified portfolio including German or Dutch govt bonds - same credit rating, no currency risk?
There are several reasons. Sometimes there is "moral suasion" which means basically the government asks them to do it. But the main one to me is this: the interest rate is higher, and the bank thinks: "if Italy fails, I am toast anyway, so I am not really increasing my risk by loading up on that scenario".
I completely forgot about the yield differential!
Do you think there is political will for a true Fiscal Union and Banking Union, or does the EU 'need' a new crisis, in other words for it to become 'Europe's problem' to act?
I am afraid we need another crisis-- there is no movement on the Fiscal front. And we probably will not be able to move all together, as the interests are not going to fully aligned. I could see for instance the Northern Europe military vulnerability incrasing (e.g. Trump/NATO) and the Nordics and some others giving a large step forward.
Isn't the ESM supposed to be designed to break the doom loop?
Sadly. It does not. As long as deposit insurance is a national responsibility, and banks are as loaded up on sovereign loans as I described, the risk persists.
having just wrote my Thesis about TPI and how it relates to the current Toolbox the Eck has at its disposal, I think the conclusion you are drawing is wrong. There would be limited incentives for Non-Italian Banks to buy Italian bonds and there would be even less Pressure for Italy to properly tax its property wealth in Order to finally fix their Budget. What you suggested in Cochrane et al (which I funnily draw upon in my thesis) seems a lot better. Create a proper default mechanism/Procedure, which is known to market participants and which is a credible threat, keeping at least partial market disciplin functioning.
Hi Adrian. Both a deposit insurance/conclusion of the banking union and the drastic reduction of sovereign bank exposures are very much part of our proposals, as well as the default mechanism. They all go together.
Banco Popular’s resolution was in 2017.
That is correct. Apologies for teh typo, correction made.