Policy Insights

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Crisis occurrence is a common problem in many European financial institutions in light of the recent financial crisis. Therefore, this has led to the need for establishment of a central body of laws and measures that avert any future financial crises. First, this has been done through the promotion of coordination and cooperation between the individual national supervisory institutions. Secondly, liquidity management has also been a tool that has proved invaluable to the process. These efforts have seen the refinancing operation rate reduce from 4.25% to 3.25%. Finally, financial agreements in form of memorandums of a non-binding understanding (MoU) between central banks, finance ministries and also financial supervision authorities have been signed. This paper shall analyze this measures as presented by Eijffinger (2008) in ‘Crisis Management in the European Union.’

The global financial crisis was first detected in 2007. Eijffinger (2008, 1) states that at ‘first there was denial, then fear and finally anger at failure of financial supervision.’ It should be noted that the first counter measures such as the memorandum of understanding were put in place in order to allow for the management of cross border systemic financial crises. Denial was characteristically emphasized by Bernanke in his speech who stated that the Fed (Federal Reserve Bank) would not tighten the existing credit standards since they global implications ‘were not severe enough.’

The discovery phase started in 2008 with banks writing off bad loans and securitization of products. Asset holdings by various banks and financial institutions had been very non-transparent and it was common practice to hide data about property links to subprime mortgages properties. Many of the banks were in serious debt as a result of the accumulation of loans on top of existing ones. The subprime mortgage crisis eventually led to the collapse of several financial institutions such as the Lehman Brothers. Due to low creditor confidence, banks with sufficient reserves were adamant in bailing out firms which were in jeopardy. Therefore, banks already in the crisis could not raise enough buffer capital or renew their short term financing. This eventually led to the disposal phase. State governments stepped in to rescue the banks that were already knee-deep in the crisis in order to raise the confidence levels and increase market liquidity levels.

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Bailouts and Nationalization of Banks

Several banks and financial institutions in Europe were assisted with emergency core capital (nationalization) in order to ‘prevent a systematic crisis from happening’ (p.2 ).Firms such as ABN AMRO and Fortis in the Netherlands, AEGEON, SNS Reaal, ING and UBS in Switzerland all received bailouts or significant financial assistance in order to stay afloat. These takeovers were instituted under certain conditions. First, the bailouts were temporary in order to keep a level playing field in the financial markets which is primarily maintained by both insurers and banks. Secondly, the government (the taxpayer therefore) faced an upward risk. Since the government was in a position to make profit as a result of the nationalization, it would have to absorb an upward risk. Thirdly, the financial institution (bank or insurer) involved faced a downward risk. Therefore, the government made it extremely hard for a firm to be eligible for bailouts in order to encourage firms to regain solvency as independently as possible.

Important Lessons from the Credit Crisis

First, the top management remuneration and reward structure was excessive. Secondly, the financial supervisors in the European Union had not been thoroughly involved. Finally, the risk management models based on Basel II had proven inadequate. Thus, the United States framework of financial supervision had proven to be too fragmented and consequently ineffective.

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Benchmarks for a New Financial Crisis

It is analogous that the bigger a financial crisis is, the more comprehensive the reorganization procedures are. This applies to large institutions that have been previously been deemed too large to fail but not too big to get reorganized. The benchmarks for the emerging financial system should be sustainability, integrity and transparency (Garcia & Nieto, 2008).

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