ESRB Says European Banking Sector Too Bloated to Boost Economy

The European banking sector has become too big to make a positive contribution to the region’s economy, according to a report published today by the European Union macro-prudential policy body.

“The European banking system has reached a size where its marginal contribution to real economic growth is likely to be nil or negative,” the authors of the report by the European Systemic Risk Board said. “Bloated banking systems have the potential to cause and exacerbate banking and sovereign-debt crises.”

Europe is still reeling from its deepest recession in half a century, triggered in part by excessive risk-taking by the region’s banks. In response to the crisis, the European Union has tightened capital requirements, introduced bail-in rules for failing banks, and appointed the European Central Bank to become the region’s single supervisor in November.

The report recommends a series of new policies to deleverage banks and return them to traditional lending activities, saying current measures may not be sufficient to address the magnitude and tackle the roots of Europe’s “overbanking problem.”

The suggestions include removing the preferential fiscal treatment of debt, a more aggressive antitrust policy, and steering the EU’s financial structure away from banks.

The report, entitled “Is Europe Overbanked?,” was prepared by a group led by Marco Pagano, chairman of the ESRB’s Advisory Scientific Committee. Other authors included Claudia Buch, vice president of the Bundesbank, Martin Hellwig, director of the Max Planck Institute for Research on Collective Goods in Bonn, and Princeton University’s Markus Brunnermeier.

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