The European Financial System Remains A Danger To European Economies

Mar. 21, 2018 6:46 AM ETFXE, EUO, EUFN, ERO-OLD, DRR, ULE, EUFX, URR, EUFL, EUFS, DEUR, UEUR7 Comments
Martin Lowy profile picture
Martin Lowy


  • The European political philosophy of finance is out of touch with today's needs.
  • Therefore regulation of banks is inadequately rigorous.
  • That leaves the banking system at risk of large-scale failures in the next recession. And that risk causes me to be cautious about investing in European renewed prosperity.

The European financial system, despite some improvements, remains rotten at the core and is a danger to many of the Continent’s national economies.

How can that be ten years after the onset of the last crisis and after so many legislative and regulatory changes? Alas, it is because the basic political philosophy has not changed.

I hesitate to hold up the American financial system as a model for the world because it has so many flaws. But the flaws in the U.S. system are minor compared with the European system’s defects.

How modern financial regulation works

Good financial regulation has to begin from the premise that banks are naturally fragile and bank managements have incentives to make them as fragile as possible. Indeed, the fundamental uses of banks to perform liquidity and maturity transformation are dangerous—and perhaps even should be outlawed, not encouraged. These common features of commercial banking naturally lead to inadequate capital and, in hard times, to runs on deposits and other short-term liabilities. (I discussed the generic problem here.)

The common regulatory paradigm for dealing with these defects is to establish regulatory capital requirements that will prevent the banks from becoming close to failure in hard economic times when losses on portfolio loans naturally increase no matter how diligent the bank may have been in the good times. And since it is the apparent lack of adequate capital that leads to banks runs, maintaining adequate capital is the linchpin of prudential regulation.

But maintaining adequate capital must be forward-looking, not based on historical financial statements, and it must include adequate provision for potential loan losses. (See Instability, my 2017 book—available for five bucks on Amazon—for the detailed explanation of why forward-looking capital and adequate provision for potential loan losses are essential tenets of bank regulation.) The U.S. regulatory regime

This article was written by

Martin Lowy profile picture
I was trained as a lawyer and practiced in the fields of corporate law and bank regulation in large U.S. firms for 20 years, then decided to do other things. My career has included banking and being an entrepreneur. For seven years I was CEO of a high-tech sports business. I have retired from active business and spend full-time writing, mostly on economic subjects. My books include: InStAbILItY: Booms, Busts, the Fragility of Banks, And What To Do about It 2017 High Rollers: Inside the S and L Debacle (1991) Debt Spiral: How Credit Failed Capitalism (2009) Practical Handbook for Bank Directors (1995), second edition due 2012 Corporate Governance for Public Company Directors (2003) Capitalism for Democrats (2019) Capitalism for America (2019)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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