Many observers have appreciated the Irish response to the crisis

Guest article Irish Examiner, January 2, 2013

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 tax payer 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 now necessary to stabilize public debt slow down the recovery of the economy which imposes an additional burden on people in Ireland. This is delicate because in the rescue measures for the banking system it has not been 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 the follow-up costs with other countries. This could be achieved 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 European Union over 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 – otherwise the incentives for national authorities to misuse the banking union would be enormous. The Japanese experience shows that is very important not to keep zombie banks alive. Like all other countries in the Euro area, Ireland would surely benefit from a European banking union in the future. 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.

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