Dublin: Ireland's economic collapse is rewriting the rules for how international regulators and investors evaluate the health of national economies and banking systems. It is also raising the risk that Europe's troubles may run deeper and last longer than expected.
Behind that shift is a growing recognition that the obligations of a country's major banks have become, in effect, obligations of the country itself — particularly in Europe, where nations commonly have banking systems in which a few internationally connected companies have liabilities far exceeding their host nation's economy.
The risks were felt acutely in Ireland, where aggressive investing and borrowing by a handful of companies saddled the government with a choice between letting its financial system collapse during the 2008 crisis or issuing a guarantee backed by the Irish state.
It chose the latter, but the tab for failed banks and bad loans became so steep the country had to turn to the International Monetary Fund and the European Union. Ireland became a prime example of a new phenomenon: banking systems that are, on a national level, "too big to save."
The same happened in Iceland — with lesser impact on the global economy, because of that country's less robust ties to international markets.
Increasingly, when analysts look at the health of European countries, they look not just at how much a government owes, how much it spends, and its sources of revenue.
They also incorporate the full scope of what its banks owe at home and abroad. The debts of a country and the debts of its banks "have become synonyms," analysts for Barclays Capital wrote in a November report. "We've had banking crises, and we've had sovereign debt crises.
"Now we have a fusion of the two," said Hung Tran, deputy managing director at the Institute of International Finance and co-author of a recent study that estimated the banking systems of European Union nations, on average, have liabilities four times as large as their national economies.
In the US, by contrast, where money is raised and lent through capital markets and other channels that extend beyond traditional banks, the figure is about one to one, Tran said.
While there is nothing inherently risky about an oversize banking system if it is well-regulated and well-run, he said, the multiples in some European countries are so large "it magnifies the scale of any problem... We've learned that countries are too small for their banking systems. They are floating without a safety net."
The issue is one reason Europe's negotiations over ways to help its struggling economies have become so protracted and tense. Expecting economically powerful Germany to help out because the Greek government spent too much over the years is difficult enough in a political context where German thrift is played against Aegean frolic.
What's being asked now is that Germany and other stronger nations stand behind not just Europe's governments but its banks as well — a far larger set of liabilities and a far riskier one, given that some nations are still closing failed banks and determining the health of others.
Substantial risk
In its recent study, Barclays estimated that banks in Spain and the Netherlands posed a high risk to their governments, while mainstay economies such as Britain, and small but still-important ones including Austria and Belgium, posed smaller but still substantial risks because of debts their banks have accumulated.
European leaders in Brussels this week agreed to set up a permanent crisis fund to help governments that are in trouble, an important acknowledgment of shared responsibility, particularly among the nations that share the euro.
But the heavy lifting — how the fund will operate, who will pay for it, and the conditions under which it can be tapped — remains to be done.
One issue is whether private investors will be asked to share losses, something Germany has insisted on at particular at a time when sovereign problems may well be stoked by bad private banking practices.
