There is some sense in the EU’s new plans to change the way in which banks are regulated. In particular, there are two major problems with the current system of regulation in the EU. Firstly, insured depositors are treated the same way as other creditors. This makes it much more difficult to manage the failure of a bank. We saw in the case of Ireland and the UK that all providers of capital to a bank (except shareholders) were treated in exactly the same way as depositors and saw very little writing down of their capital. Secondly, there is a disconnect between deposit insurance systems, regulatory oversight and central banks. We saw this problem in the case of the failure of the Icelandic banks: nobody was sure who was insuring whose deposits and our own government ended up using anti-terrorist legislation, quite inappropriately, to try to extract assets from the failed Icelandic banks. These co-ordination problems are even worse in the Eurozone countries given that the ECB effectively has to make judgements about whether to provide lender of last resort facilities to the banking systems of different countries without having the knowledge about the solvency of the different countries’ banking systems.
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