A banking accident waiting to happen

The rolling crisis among Europe's lenders has been painfully apparent this year. In Spain, Banco Popular had to be rescued in June, in part because of a run on the bank by depositors nervous of getting their money back. In Italy, the government intervened to resolve a crisis at Veneto Banca and Banca Popolare di Vicenza at a cost of around €17bn. And no one believes that those two are more than the tip of a very big iceberg. Italy alone has an estimated €130bn of bad debts in its banking system. There will be lots more in other countries.

There is, however, no problem so bad that the European Union can't come up with a way of making it worse. Its latest idea? A paper last week proposed freezing the accounts of depositors at any bank when it runs into trouble, so that a run on the bank could be stopped in its tracks. The ban would be imposed by the EU, and people would only be allowed to take out the cash they needed to get by day-to-day. An earlier proposal also planned blocking accounts, but only above €100,000. This one would hit ordinary savers as well.

Of course, you can see what they are getting at. Ever since the crash of 2008, regulators across the world have been grappling with ways of coping with a collapse of confidence in the financial system. Last time around, governments in effect guaranteed deposits and that ended up costing tens of billions in bail-outs. This way, they could put a fire-break in place, and hold the money in a bank until the situation calmed down. It is far cheaper for the state, and it also means that savers will be a lot more cautious, and a lot more responsible, about where they park their cash.

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This is the trouble. It sets up the wrong incentives. At the first hint of a problem with a bank, investors will rush to get their money out, because no one will want to be left with funds in an institution when the money is frozen. There will be a good chance they will lose all of it. Even more seriously, they will start to avoid any bank over which there is the merest hint of suspicion. Why would you risk holding cash in an Italian or Spanish bank when you can hold it at the same interest rate in a German or French one and not have to worry about it being frozen? There is no reason at all. You are just taking on unnecessary risk. The banks in those countries were already in trouble. The EU just made them an even worse bet. Clever.

At the same time, plans for a proper banking union look to have been shelved indefinitely. There have been plenty of different proposals, from a single regulator, to making the European Central Bank the lender of last resort for banks across the zone, as the Bank of England is in this country, or the Federal Reserve in the United States. In Brussels, they have been working on that since 2012 which was already about 12 years too late and have not made any serious progress yet. A couple of directives have been passed, which laid down rules that were meant to apply across the continent. But then, when Italy needed to rescue its bank, it was completely ignored.

The answer is simple. The ECB should regulate banks, and the governments of the single-currency area should jointly stand behind each one. That might be unpopular with voters, but nothing else will work. Until it happens, the eurozone is a banking accident waiting to happen. The imbalances created by the currency have to be recycled through the financial system, creating vast flows of money across borders. Without proper regulation, sooner or later that will blow up. The EU needs to be working out ways to fix that instead it is making it worse.