EUROPEAN UNION
FINANCIAL MARKETS AND
INSTITUTES
GLOBAL FINANCIAL CRISIS: EUROZONE FOCUS
Contents
EXECUTIVE SUMMARY ............................................................................................................ 3
INTRODUCTION .......................................................................................................................... 4
EUROPEAN UNION DEBT CRISIS ............................................................................................ 5
RESPONSES OF BANKING AND SUPERVISORY STRUCTURES TO EURO ZONE CRISIS
......................................................................................................................................................... 5
ADEQUACY OF THE RESPONSES ............................................................................................ 6
CHANGES IN EU SINCE THE CRISIS BROKE ......................................................................... 7
FISCAL AND MONITARY POLICY CHANGES.................................................................... 8
STRUCTURAL POLICY CHANGES ....................................................................................... 9
BUSINESS SUPPORT AND INVESTMENT POLICY CHANGES ........................................ 9
FUTURE OF EURO ..................................................................................................................... 10
CONCLUSION ............................................................................................................................. 12
REFERENCES ............................................................................................................................. 13
2
EXECUTIVE SUMMARY
In a financial crisis financial assets lose a large part of their value and often result in collapse of
some important financial institutions in a short period of time. Reasons behind the financial crisis
involves variety of situations such as financial market is not regulated properly, risk is
underestimated, financial leverage, speculative attack etc. The financial crises which take place
due to these reasons mainly include market bubbles and crashes, banking crisis, currency crisis
and sovereign default. Entire European Union is also going through tough phases of Sovereign
Debt Crisis. Due to this ongoing debt crisis which is also known as Euro zone Crisis, many
countries are finding it difficult or impossible to repay the government debt and they are in the
need of intervention of third parties. These countries mainly include Greece, Ireland, Italy,
Portugal and Spain. Group of these countries are referred as PIIGS. Third parties which can help
these countries by providing financial aid are ECB, IMF and World Bank as well as other
financially developed countries (Investopedia n.d.).
While talking about the adequacy level of the efforts of banking and supervisory structures at EU
level we found that these supervisory structures such as government of these countries and other
international financial institutions are trying to bring new policies and economic reforms so that
they can protect these nations from default. The economic reforms applied by the banking and
supervisory structures include direct loans to the banks which are suffering due to the crisis as
well as some strict regulations to regulate the banking practices in these nations. Less Austerity
and more investment is another economic policy applied by the government officials and other
financial institutions. Increasing the competitiveness of these nations and mobilizing the credit
are other objectives of the supervisory structures of euro zone to protect EU from default. Thus,
we can say that there are many changes that have been brought since the crisis broke and these
changes took place mainly in the domain of economic policies and banking practices of these
suffering nations. If we look at the Euro Zone crisis from the perspective of policy making we
find that first priority of policy makers is to reduce the sovereign solvency risk and tackle
contagion (Santis 2012).
Considering the future of Euro after the EU crisis we find that if any country defaults then it will
have negative impact on the economy of the country as well as on the single currency “euro.”
And we all know the importance of European Union in world economy. If the euro will collapse
3
then it will not only affect the European Union but also the entire world’s economy (Money
Week 2013). To deal with the tough conditions of Euro there is a group of ministers which looks
after the performance of Euro. The highest priority of the group is to heal the rift over the
austerity policies between the northern and southern nations (Kanter 2013).
INTRODUCTION
A financial crisis is a variety of situations in which the financial assets like government bonds
private bonds, stock market etc lose a large part of their value. This is often followed by the
collapse of important financial institutions like banks, private companies, financial institutions
etc. There are many factors which are responsible for the financial crisis e.g. speculative attack,
underestimation of the risk, lack of market regulations, leverage financing, mismatch of the
assets and liabilities and heard behavior etc. The financial crises which occur due to these
reasons are also named accordingly such as banking crisis, currency crisis, market bubbles and
crashes and sovereign default. A banking crisis means the banks are facing the problem of huge
withdrawal and are in liquidity problems. Famous banking crisis took place in the United States
in 1931 (Reinhart & Rogoff 2008). Similarly, speculative bubble is another financial crisis in
which securities are traded above their intrinsic value and creates a situation of market bubble.
The famous examples of speculative bubbles are Wall Street crash in 1929 and dot com bubble
in 2001(French 2010). In the same manner when currency of a nation gets devaluated sharply
then it is known as currency crisis.
In our report we would be focusing on the financial crisis in euro zone in last decade. A brief
description of the reasons behind the crisis will be given at the initial level and then we would be
investigating the responses of the major financial institution and supervisory structures against
the financial crisis in euro zone. These financial institutions tried to change the policies of the
countries in the euro zone. The changes which have been made will also be discussed in the
report further. This financial crisis in euro zone had a big impact on the single currency of
European Union named “Euro.” A detail analysis of impact on Euro and its future as a single
currency of European Union will also be discussed.
4
EUROPEAN UNION DEBT CRISIS
European Union debt crisis is the financial crisis which started in the last decade. The main
reason behind the crisis is the high level of government debt due to which many countries of the
European Union are not able to repay the debt that they have taken from the external financial
institutions and countries and now they are in the need of external assistance of third parties like
IMF and ECB. The crisis started taking place in late 2009 and the reason behind the fear of
sovereign debt default is different in different countries. The main countries which are facing the
problem of debt default are Portugal, Italy, Ireland, Greece and Spain. All these nations have
different problems.
Crisis started in Greece due to the extra borrowing and spending in 2004 Olympics by Greece
government. The government eventually became unable to repay the debt taken and to repay the
debt it again took the debt at higher interest rates which became a big difficulty for the country as
billions of euro in due to repay. Other members of the union created an institution to prevent
Greece from default which known as European Financial Stability Facility (Mulhearn & Vane
2011). In Spain the crisis started due to the higher financial support to other countries as it was
the nation with minimum debt to GDP ratio. It provided a bailout of 19 billion euro to Bankia. It
was also involved in high level of real estate investments and required 59 billion euro to cover
the losses (Trading Economics 2012). Similarly, Ireland, Portugal, Italy and other countries had
their different reasons for crisis.
RESPONSES OF BANKING AND SUPERVISORY STRUCTURES TO EURO
ZONE CRISIS
The responses of banking and other supervisory structures to the euro zone debt crisis is quite
interesting as there are many terms and conditions which have been put by these supervisory
bodies on the nations requiring monetary help. The main banking and supervisory structures are
European Central Bank (ECB) and International Monetary Fund (IMF) as well as government of
these nations. The countries in the European Union have understood that they need external
assistance in solving the solvency problems and these supervisory structures are also ready to
help them in fighting against the crisis. The 15 Euro zone countries have come out with an
agreement of bailout plan that the government will buy equity stakes in banks and will also
5
provide new borrowings to unblock the interbank market. ECB also announced that it will create
an unsecured lending facility to purchase the commercial papers by banks (Hewitt 2012).
The members of European Union made a group tried for the domestic adjustment plans. These
domestic adjustment plans mainly include European Financial Stability Facility (EFSF) and
European Financial Stability Mechanism (EFSM). This integration of the EU framework has
played an important role in tackling the financial crisis. These member nations have also created
external support for the domestic adjustment programs which was introduced by Ireland and
Greece. These financial support programs have put strict conditions of the countries who are
receiving the external financial help. These adjustment programs asked for major changes in the
economic policies of the recipient nations which mainly included fiscal consolidation,
restructuring of the financial sector as well as broader structural reforms. EU and IMF both have
equally put these conditions on the crises nations. The EU countries insisted highly on the
involvement of IMF because of the credibility that it provided to the nations in distress (Smaghi
2011).
European authorities not only played an important role in fiscal consolidation of the affected
countries but also offered support to the financial systems of the highly affected countries. These
things have been done together by EU and IMF for the recapitalization and restructuring of the
banks. The supervisory authorities ensured that liquidity continues to flow in the countries
affected badly. Another thing which is noticeable in the responses of the supervisory authorities
is that the actions were taken by taking the entire EU into the considerations. The responses were
not country wise by the perspective of the responses were entire EU. To deal with the financial
crisis many institutions were formed such European Supervisory Agency and other three new
European Supervisory Agencies.
ADEQUACY OF THE RESPONSES
While looking at the adequacy level of the responses of these supervisory authorities we find that
these programs were able to support the nations suffering from financial crisis but not
completely. The objectives of the policies applied by banks and supervisory structures are clear
but the design and implementation of the policies are unclear. If the governments are saying that
they will purchase the equity stake in banks then how are they going to decide the equity stakes
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bought in the distressed banks? It is obvious that the government will not be purchasing the
equity stakes in the banks irrespective of the degree of solvency of banks. Similar issues are
there with the provisions of loan and commercial paper purchases. It is also an issue that the
governments will have wide spread control over banks and this control will go longer.
Another concern is that whether the governments of these countries will behave like a passive
investor or wield some control over the key decisions of the banks that they bail – out. History of
world’s financial crisis reveals that government pays an important role in the key decision
making of the financial institutions that they bailed out. Examples of this are Reconstruction
Finance Corporation created by President Herbert Hoover in 1932 and Institute of Industrial
Reconstruction (IRI) created in Italy during the period of great depression. Same thing took place
in Sweden in the financial crisis of 1990s when government first bailed out the banks and then
forced the banks for mergers and replaces the key executives. These things raise questions
against the adequacy level of the responses of supervisory structure of the EU (Kanter 2013).
Another important issue is the bailing out the large European Banks which have subsidiaries
cross border. How the government will go to bail out them? European governments have decided
that they will bail out the banks at national level but this response will not solve the problems of
bigger banks in EU and solvency of these bigger banks are essential for stability of the European
credit market. This proves that the efforts made by the governments and other external and
internal financial institution are inadequate.
CHANGES IN EU SINCE THE CRISIS BROKE
There are many changes that have been brought since the crisis is broke. These changes mainly
took place in the areas of the politics, financial markets, rules and regulations in financial
markets as well as banking structures. Fiscal and monitory policies were changed by the
governments and new policies were adopted. Also the external parties who helped in fighting
with the crisis asked for regulatory changes. The terms and conditions that have been put on
these countries made them difficult to operate according their own objectives and hence they
asked for negotiations as well. The aim of the changes that have been is the more and more
binding between the different euro zone countries (BBC News 2011).
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FISCAL AND MONITARY POLICY CHANGES
Considering the economic policy changes we find that the government and other financial
institutes like ECB applied different monetary and fiscal policies to gain the stability in EU. ECB
cut the interest rates to help the other banks. Also many groups were made to supervise the
different economic activities of the nations. For example securities market programs were
launched and for it special purpose vehicles e created such as EFSF/EFSM. These bodies took
care of the fiscal consolidation and structural reforms in the EU. To prevent banks from the crisis
banking recapitalization took place at the national level. Cheap liquidity was provided to banks.
Also the internal devaluation has been done to deal with the imbalances in the competitiveness
(McDonnell n.d.).
In October 2008 the European Council proposes to increase the minimum protection for bank
deposits to 100,000 euro. In November 2008 the European Council agrees on approaches of the
reforms of international financial systems. The commission also adopted European Economic
Recovery Plan (EERP). During the time period of 2008 – 2009 the ECB cut the interest rate and
reached to the level of 1% in May 2009. The crisis in the region enforced the ECB and
government for extraordinary expansionary stance of macroeconomic policies. From the above
facts we can easily understand that ECB tried to lower the borrowing cost to bring stability in the
credit market. A graph provided below will represent the clear picture of macroeconomic policy
changes in European Union before and after the crisis.
8
It is clear from the above graph that the tension in the market was handled by tightening the
fiscal and monetary policies. ECB was the major financial institution who addressed the problem
by providing larger liquidity provisions (European Commission 2009).
STRUCTURAL POLICY CHANGES
Not only the fiscal policies but also the structural policies changed over the time. Structural
policies were aimed at the growth and job potential in the EU. These policies mainly included
changes in labor market policies and business support and investment policies. The working time
got rearranged and made flexible to increase the job opportunities and financial support was
provided to those countries which were affected badly. An investment was also made in
providing the training and developing new skills in workers. To mitigate the direct impact of
financial crisis on the individuals’ access to the financial services were increased. In many
countries the pension system was analyzed and changed as per the requirements of the
pensioners. Free movements of workers were also made easy in single market. Other objectives
of the labor policies included the increasing employment in youth and early school leavers.
BUSINESS SUPPORT AND INVESTMENT POLICY CHANGES
Financial crisis also affected the private sector at a great scale. Due to the tightening credit
standards it became difficult for the large private institutions to borrow and situation became
worst for the SMEs. Private companies and consumers scaled down their investment plans
because of the tightening credit policies, lowering confidence, unfavorable market conditions
and uncertainty in the future development. EERP recognized that it is required to support the
business activities in the region and it brought some policy changes. In March 2009 European
Commission set out some guiding principles to support the private business which is also known
as “Driving European Recovery.” The member states of EU were required to follow these
guidelines in order to support their private sector.
The guidelines mainly included maintenance of openness in the internal market so that barriers
can be removes and new barriers don’t come out. Also there should not be discrimination in the
trading of goods and services from the other members of the EU which are financially strong.
The guidelines were made for achieving the long term benefits such as facilitating the change in
the structure of the private businesses, enhancing the competitiveness of the businesses as well as
addressing the key challenges like creation of a low carbon economy. Apart from above other
9
policies were information sharing and best practices. The single markets were kept open for
trading and international commitments were given importance (European Commission 2009).
If we look at the current situation of the European Union economic changes we find that group
of ministers are trying to handle the difficult situation efficiently. Last year in Brussels the
leaders from European Union tried to decide the budget for next seven years but the meeting did
not end successfully. The 27 leaders are still in confusion about the approach that they should
apply in budget planning i.e. less spending or better spending but not both. There is a hope that
these leaders will come out with some strong budget policies to handle the difficult financial
situation (Barnes 2011). All the above discussed economic policies and changes in the policies
will have definitely an impact on the single currency of European Union which is discussed
further in the report.
FUTURE OF EURO
The future of single currency Euro depends on the economic policies applied by the European
Union members. Currently the banks and other supervisory authorities are trying to get EU out of
the financial crisis by applying different monitory and fiscal policies which will surely have an
impact on the value of Euro. These policies can have two fold results as they may fail or if the
correct policies were applied the Euro zone can come out of the debt crisis and if it happens it
will obviously make the Euro stronger.
During the time period of 2008 – 2010 several things in the largest union of the world went
wrong. The main reason behind the Euro crisis was unsound fiscal policies of Greece. Its Debt to
GDP ratio went higher which affected the currency as well as the country was not in the situation
of either printing the currency or devaluating it. Looking at the situation of Euro and other
suffering countries we can easily say that future of Euro is not bright.
There is a group of ministers made to oversee the performance of Euro after the debt crisis has
taken place. This group of ministers headed by Mr. Jeroen Dijsselbloem is highly focused on the
Austerity measures to avoid the mistrust between the northern and southern countries which are
using Euro as their currency. Objective of the group is to improve the image of the currency.
There are some political uncertainties which are affecting the future of the currency such as the
austerity policies applied by the northern nations of EU are not in the favor of southern region
10
nations and Spain is ignored highly. Northern countries like Finland, Netherland and Germany
pay less to borrow than the countries which are weaker in the credit ratings. The group clearly
says that if the tension between the northern and southern regions is not eliminated then surely
we are not going to get the improved situation of Euro (Kanter 2013).
Due to the poor conditions of the important EU members there is a big difference between the
different financial products in different regions of the union such as pricing of credit default
swaps (CDS) differ in western and eastern European regions. In simple words we can say that
the bond holders in Western Europe want higher rate of return than the in the Eastern Europe.
The Eastern European states are partially absorbed into the EU and can leave the EU as early as
possible and this would have a great impact on Euro. We all know the importance of European
Union as a whole for the world economy. Its contribution to the world GDP is highest and more
than the United States.
(Source: European Commission 2012)
Above diagram clearly explains the importance of EU to the world economy. If the countries in
the union suffering from the crisis don’t overcome the problem then it will not only affect the
euro but also the world economy as well as other currency.
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CONCLUSION
In conclusion we can say that European Union has come to this stage because of its inappropriate
policies like lack of regulation in the banking sector, insensible investment in real estate,
unsound fiscal policies etc. The main countries which are responsible for this situation are
Portugal, Ireland, Italy, Greece and Spain. In these countries Greece is the biggest problem and if
it defaults it will have a negative impact on the entire euro zone.
To protect these countries from default banking and other supervisory structures like European
Commission are trying a lot. There are many plans and policies which have been made and still
are getting made by these supervisory authorities. These plans mainly include securities market
programs and creation of special institutions like EFSF and EFSM. Apart from this many
monetary and fiscal policies are being made to get the financial situation of the euro zone stable.
Not only government of these countries but also the other authorities e.g. IMF and ECB are
making many efforts to protect these nations from default. These efforts have brought many
changes in the economic development of the union. E.g. ECB tried to get the financial market
stable and for that it cut the interest rate and reached to the level of 1%. Obviously, these factors
are affecting the future of euro as well.
The other financial markets are investigating the ability and willingness of European authorities
to preserve the euro as a currency and the institutional responses have been very strong in order
to prevent the euro zone. Yes, there are some questions which can be raised against the policies
applied by the euro are to understand the adequacy level of the responses but overall the situation
is now improving. The union has implemented a set of measures to ensure the provision of
liquidity in the euro area. Europe will be able to emerge from its current problems if the
weaknesses revealed by the current debt crisis are identified and corrected through new policies
and reforms.
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