The European leaders appear to have agreed on tougher fiscal discipline, such as balanced budgets on the part of individual countries. However, according to Reuters, Germany stands between critical steps being passed - issuing of Eurozone bonds and allowing the European Stability Mechanism (ESM) to become a bank.
Issue of Eurozone bonds will pave the way for greater fiscal union in Europe. And as a banking entity, ESM will be able to raise resources from the market and operate with some degree of corporate freedom. It would now bank on country contributions. ESM, which goes into effect in 2013, has kept a window open for non-Eurozone participation.
The recent summit reveals the fractured opinion across the continent as country leaders seek to protect their turf. The UK for example, refuses to sacrifice its own interests to resurrect the Eurozone.
Apart from the political wrangling and one-upmanship, Europe's problem emanates from a) losses from US sub-prime and other structured products, b) structural issues, like- real estate asset bubbles and c) sovereign debt crisis stemming from the recession and poor fiscal governance.
The Maastricht Treaty (1992), which created the euro, too had prescribed strict fiscal guidelines. The failure on the part of Eurozone members to toe the treaty perpetrated the present crisis. Will the new European initiative usher in a new dawn?
Negative fallout of the crisis will be severe on the banking sector. HSBC Holdings Plc ( HBC ), Europe's largest bank by market value and UBS AG ( UBS ), Switzerland's largest bank recently faced credit ratings downgrades.
According to the OECD, European banks are not as well-capitalized as the US banks. They follow the Basel system of capital adequacy to risk-weighted assets (RWA) without recognizing the relationship of RWA and total assets ( TA ). The banks therefore, indulged in high leverage.
Major US banks - Bank of America ( BAC ), Citigroup ( C ), JP Morgan ( JPM ), Wells Fargo ( WFC ), Goldman Sachs ( GS ), Bank of New York Mellon ( BNY ) and Morgan Stanley ( MS ) have also not been spared downgrades.
According to the Bank of International Settlements, US banks have an exposure of $767 billion to the European debt market. Credit Default Swaps ($518 billion) and direct lending ($181 billion) are major parts of this exposure. A wobbly Europe and exposure to its debt would have pushed for the downgrade.
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