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Overcoming the Debt Crisis by European Banking Sector Case Study

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Introduction

The European crisis is the financial crisis that affected and is still affecting countries within the euro zone. This crisis is majorly attributed to the countries’ inability to repay their debts free of assistance that comes from third parties.

Various intervention measures including, European financial stability facility, European fiscal compact, and integration of bank managements among others have been tried with an aim of ending the crisis. This paper seeks to address the major issues facing the European banks with an aim of showing how the European banking sector helped in overcoming the debt crisis using the above intervention strategies as the basis.

Major Issues Facing the European Banks

There are several major issues facing the European banks. First, the European crisis is a financial crisis, which affect some governments in Europe such that they are unable to repay their debts without intervention from other sources (Ibrahim 123).

Since the onset of this crisis in 2007, government and private sector debt has continued to rise because of the increased levels of private and government debts in the world and the downgrading of debts owed by government in various states in Europe.

Due to the increase in property bubble, private debts easily became sovereign due to bailouts by banks and governments in a reaction to stop the post bubbles of the economy. This crisis has threatened to split the European Union. In addition, inability to sustain the wages and pensions by the government of Greece has led to intensification of the debt crisis (Cecchetti and Zampolli 23).

Worse still, Greece has always tried to hide its financial position through the assistance of major well-established banks in Europe (Louise and Schwartz A1). Some banking institutions have benefited from this action though it was short lasted since the crisis soon became so glaring.

Another major problem facing the banks is that the Euro zone uses one currency with a variation in taxation and in public pension regulations. This strategy means that the banks cannot respond to this crisis with efficiency.

According to Seth et al., most banks in the European region have big debts, which make them have their solvency questioned (19) thus affecting the economy negatively. This crisis worsened in 2010, 2011, and 2012. The European countries are therefore trying various intervention methods though they have not yet succeeded.

Resolution strategies

Various intervention measures have been carried out by the banking sector to help in ending the crisis. Such methods include the creation of European financial stability facility, banks writing off 53.3% debts from individual creditors, and the creation of European fiscal compact (Pidd 5).

The worst hit countries include Ireland, Portugal, and Greece. Spain also became hard hit in 2012 after its interest rates shot up and began influencing its power in capital markets thus leading to its banks being billed out. The other way of resolving the crisis was through integration of the banking administration with the insurance.

Today, the European countries are working on integrating European Union banking administration with all-inclusive oversight insurance in a bid to save the collapsing banks. The EU central bank also checks on money flows through the provision of lower rates of interest besides giving the failing banks cheap loans. The banking sector also played a big role in the development of the Euro Plus Pact.

European countries have begun implementing the Euro Plus Pact, which aims at changing the political standing, the monetary position, and the competitive ability of the European region. The EU Banks have also provided economists who have advised on adding investments on the public and the levying of friendly taxes that consider growth especially on wealth, property, private sector, and financial institutions.

Banks have also overseen the enactment of Macro-prudential supervision where countries create financial stability oversight councils to identify the risks that may threaten the financial wellbeing of these nations.

The councils promote market discipline and communication for instance by ending the financial cushions from losses of both non-financial and financial institutions in case of a crisis besides responding to threats that may emerge in the financial status of the countries (Wynne 19).

This strategy also involves the enactment of micro-prudential supervision, which administers and regulates thrifts, banks, holding companies, and the non-bank institutions. Majorly, it covers the financial organisations and utilities of financial markets.

The banks also cater for the correction of key aspects of the regulatory framework, which will control elements like accounting standards, capital rules, and credit controlling agencies. In addition, banks also offer crisis management and resolution framework that addresses the risks of lending and borrowing.

They guarantee finance, products, and concentration of any financial markets disrupters. According to Wynne, the banking sector protects customers from hidden charges, deception, and abusive conditions during the exchange of goods and services.

The future implications to the banks and its stakeholders

One of the future implications to the banks and its stakeholders is that there will be less likelihood of employment stabilisation at the equilibrium in Europe because unemployment is resulting from national debts more than from individuals (Ceccheti and Zampoli 45).

This claim means that, since this economy is dependent on third party intervention, there is a likelihood of taking many years to recover and restore full employment potential.

Secondly, the classical view of demand and supply indicates that, whenever there is an increase in output of services or goods, there will be an automatic rise in spendable income. One can therefore deduce that the economic crisis in Europe is affecting the supply itself.

Hence, it will result in limited demand in the future. Unemployment resulted from inability by the governments in European zone to repay their debts hence reducing the available income to pay employees (Ibrahim 12). As such, there will be no balance between the amount of money in supply and that in circulation.

The product of the amount of money available for circulation and the velocity of its circulation is supposed to be equal to the product of the average level of prices and the number of transactions that take place. In the case of Euro crisis, the equation will not apply since the amount of money in circulation is already low with much dependence being on third party aid.

The speed of its circulation is still low due to unemployment thus being unable to equate the price levels and transactions taking place. On the same note, different levels of taxation in different countries may make the crisis more severe since some countries like Greece have increased money supply hence setting in inflation.

Loans create deposits. Therefore, inability of the European countries to re-finance their loans may worsen the economic crisis in Europe. Banks in the European countries may not even have money to lend since there are no willing borrowers due to unemployment and unpaid wages.

Moreover, from the endogenous theory, a bank can never suffer from capital constrain because banks can obtain funding for their reserve (the central bank or from the interbank market).

Seth et al. affirm that, in the European zone, countries have not been able to repay their loans alone because the central banks in these nations suffer from capital constrains meaning that there are no funds for internal loans and that the national economies of these nations have to depend on foreign nations.

Finally, in the future, banks will pursue all profitable opportunities to lend money. This strategy will therefore mean that European countries may face difficulties in ending the economic crisis facing them since banks are not able to obtain money from their central banks unless this money is borrowed.

Their inability to re-service loans may also mean that the banks will have a problem in controlling the circulation of money to other loaners. The profit margins for the banks will also be reduced.

Risks involved and how they were overcome

There were several risks involved in the process of solving the crisis. According to Ibrahim, one of these risks was the macroeconomic risk, which resulted in the vulnerability of sovereign nations to economically advanced nations, which in turn weakened the ability of the European nations to sustain debts.

This risk is being tackled through encouragement of sustainable development in countries like Greece and Portugal. Ibrahim also reveals market and liquidity as other risks that were involved following the increased sovereign risk and macro economic developments.

The risks have resulted in the decline in investor confidence. Rise in government bond productivity together with the increased volatility have also weakened the investor confidence thus resulting in difficulties in funding public debts by the banks.

Efforts to stabilise the macroeconomics risks have been focused on with little yields. Credit risk is another problem that has resulted from the overflow of sovereign strains into banks in Europe. This risk has negatively affected funding, as well as cutting the credit flows in the economy. To curb this risk, the banking sector is trying to reduce the credit risk by reducing the spill over of sovereign strains to the banks.

Conclusion

In conclusion, the European crisis is majorly attributed to the Euro zone countries’ incapacity to repay their debts free of support that comes from third parties. Banks in Europe have had many issues arising from the crisis.

Some of the major issues facing them include financial crisis that has made governments unable to repay their debts, rise of government and private sector debts, increase in property bubble, and their inability to sustain wages and pensions by the government.

The implication here is a less likelihood of employment stabilisation, automatic rise in spendable income, lack of balance between the amount of money in supply and that in circulation, and inability of the European countries to re-finance their loans.

However, central banks in these nations suffer from capital constrains. As such, they will pursue all profitable opportunities to lend money. The risks involved include macroeconomic risk, credit risk, market, and liquidity risk.

Works Cited

Cecchetti, Stephen, and Fabrizio Zampolli. The real effects of debt. London: Bank for International Settlements, 2011. Print.

Ibrahim, Haider. “Sovereign Credit Risk in the Euro zone.” World Economics 13.1(2012): 123-136. Print.

Louise, Thomas, and Nelson Schwartz. Wall St. Helped to Mask Debt Fuelling Europe’s Crisis, 2010. Web.

Pidd, Helen. Angela Merkel vows to create ‘fiscal union’ across euro zone. London: The Guardian, 2011. Print.

Seth, Feaster, Schwartz Nelson, and Tom Kuntz. NYT-It’s All Connected-A Spectators Guide to the Euro Crisis. New York: Word Press, 2012. Print.

Wynne, Godley. Maastricht and All That. London: Routledge, 1992. Print.

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IvyPanda. (2019, April 18). Overcoming the Debt Crisis by European Banking Sector. Retrieved from https://ivypanda.com/essays/overcoming-the-debt-crisis-by-european-banking-sector/

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"Overcoming the Debt Crisis by European Banking Sector." IvyPanda, 18 Apr. 2019, ivypanda.com/essays/overcoming-the-debt-crisis-by-european-banking-sector/.

1. IvyPanda. "Overcoming the Debt Crisis by European Banking Sector." April 18, 2019. https://ivypanda.com/essays/overcoming-the-debt-crisis-by-european-banking-sector/.


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IvyPanda. "Overcoming the Debt Crisis by European Banking Sector." April 18, 2019. https://ivypanda.com/essays/overcoming-the-debt-crisis-by-european-banking-sector/.

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IvyPanda. 2019. "Overcoming the Debt Crisis by European Banking Sector." April 18, 2019. https://ivypanda.com/essays/overcoming-the-debt-crisis-by-european-banking-sector/.

References

IvyPanda. (2019) 'Overcoming the Debt Crisis by European Banking Sector'. 18 April.

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