Nov. 13 (Bloomberg) -- Irish Central Bank Governor Patrick Honohan said a common deposit guarantee regime and an agency to deal with failing banks are key to the redesign of the euro.
“It is true that there are subtly different expectations concerning what can and will be achieved,” Honohan said in a speech today in Edinburgh. While the setting up of a single supervisor “is in full active preparation,” a bank deposits backstop and resolution regime are also “very important elements of euro 2.0,” he said.
Leaders agreed to move forward with common bank supervision led by the European Central Bank as a way to separate risks in the financial industry from sovereign debt troubles, with the goal of agreeing on a political framework by Jan. 1. If a common supervisor is set up next year, it would open the door for the euro area’s firewall fund to offer direct aid to banks.
While Honohan said it’s not within his remit, politicians involved in looking at the future of the euro need to ensure the region maintains popular support for the changes.
“You can’t go to where this system needs to be without an improved structure of democratic legitimacy,” Honohan said in a question-and-answer session after his speech. “It is recognized by the people who are concerned in the debate that this is a dimension we need to strengthen.”
Honohan, 63, has led the Irish central bank since September 2009, a year after the nation guaranteed its ailing banks and just as Europe headed toward its debt crisis. The country was forced to seek an international bailout 14 months later following the near collapse of its banking industry.
“The view from Ireland, one of the economies most damaged in the crisis, allows us to see just how release 1.0 of the euro was under-designed and robust only to moderate shocks,” he said in the speech organized by the David Hume Institute.
While financial markets didn’t always enforce discipline on countries before the crisis as they ran up debt at an excessive rate, their “reassessment of the degree to which things can go wrong has generated a potentially lethal combination of high yield and high debt,” Honohan said.
The yield on Ireland’s benchmark 5 percent security due in October 2020 rose two basis points to 4.77 percent today. While it’s down from 14 percent in July 2011, the yield on 10-year German debt was 1.34 percent.
Honohan said he expects gaps to remain in yields between euro countries.
“We’re in for a period of time where spreads are going to remain different for quite a while but we don’t want to see tham at 300 or 400 basis points,” Honohan said. “We can see a degree of narrowing in the short term but it’s going to be a long time before we see them converging again.”
It has been argued that the ECB could have moved sooner to try and resolve the euro-region debt crisis, he said.
“History is of course littered with at least as many unhappy episodes consequential on hyperactive central banks and those which were destructively compliant with the desires of spendthrift governments and imprudent bankers as with those resulting excessive central bank caution,” he said.
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