Financial sector aspects have pervaded the euro-area crisis, which can be seen as much as a financial sector crisis as a sovereign debt crisis, even though the latter narrative has dominated media coverage and political perceptions. The fragility of sovereigns in the euro area was to a great extent (though not in Greece) the result of large implicit and explicit state guarantees to national banking sectors.
The International Monetary Fund made a significant contribution to addressing the euro area’s financial sector challenges. The euro-area crisis exposed the unsustainability of the then-existing European Union banking policy framework. National authorities were ineffective in supervising banks adequately in the run-up to the crisis, and did not manage and resolve financial sector aspects of that crisis in an effective and timely manner. EU institutions, including the European Central Bank (ECB), did not generally have the skills, experience or mandate that would have enabled them to offset the national authorities’ shortcomings. The IMF was thus in a position to make a major positive difference.
At the euro-area level, the IMF played a ground-breaking role in understanding the dynamics of the crisis and promoting banking union as an essential policy response. The IMF was the first public authority, and one of the first movers more generally, to acknowledge the role of the bank-sovereign vicious circle as the central driver of contagion in the euro area. It was also the first public authority to articulate a clear vision of banking union as a policy response, building on its longstanding and pioneering support for banking policy integration in the EU. Even though its advocacy on these issues was not entirely consistent and continuous, the IMF can claim some credit for the euro area’s breakthrough decision in mid-2012 to initiate the banking union; this decision was the most important turning point in the entire sequence of crises.
In individual countries, the IMF’s approach to the financial sector was appropriate and successful in several, but not all, cases. The Stand-By Arrangement (SBA)-supported programme in Greece preserved short-term financial stability, but many of its financial sector aspects are difficult to assess on a stand-alone basis since it was followed by further IMF assistance (which falls outside the scope of this evaluation). With the Extended Fund Facility (EFF)-supported programme in Ireland, the IMF contributed significantly to the effective resolution of a major banking crisis in that country, and so did the Financial Sector Assessment Programme (FSAP) and subsequent IMF technical assistance in Spain. But the opportunity to clean up the financial sector was missed in the EFF-supported programme for Portugal.
The IMF should preserve, update and develop the institutional knowledge it has acquired about the EU financial sector framework. The Fund’s positive contribution to addressing financial sector aspects of the euro area crisis is widely acknowledged by European policymakers, providing a promising basis for future engagement. The IMF should devote particular effort to adapting its processes and methodologies to the new context of banking union, which, for the euro-area countries, makes it increasingly difficult to consider financial sector issues on a national basis.
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Compliments of Bruegel – Author Nicolas Véron