The European Twin Sovereign Debt and Banking Crises

Abstract

Europe currently faces a severe economic and financial Great Crisis. It is often described as a sovereign debt crisis, but in fact it is really a sequence of interactions between sovereign problems and banking problems that caused a severe economic slowdown. It also caused a fragmentation of euro area financial markets. The explanation of the crisis focuses on the imbalances of European Monetary Union (EMU) countries balance-of-payments, where TARGET2 payment system became crucial, reflecting funding stress in the banking systems of crisis-hit countries. The decisions by European leaders to set up a banking union and the announcement, as well as adoption, of non-standard measures by the European Central Bank (ECB) greatly contributed to restoring confidence in euro area financial markets, improving market sentiment and reversing the earlier trend towards market fragmentation. Anyway, an expansion of European aggregate demand is needed to promote growth, and to this aim the role of Germany is crucial

Reshaping the Banking Sector in Europe

“…The sovereign debt crisis of 2008 has contributed to the instability of the sector [9]. [10] argues that there is a strong interdependence between sovereign credit and banking systems. [11] found in their empirical study that the crisis had a significant impact on worldwide mergers and acquisitions, and more significantly they found that the emerging market banks acquired banks targeting neighboring countries and European countries.…”

Flight-to-quality and contagion in the European sovereign debt crisis

“…As some European countries were experiencing macroeconomic imbalances, the US Subprime crisis created the conditions for the emergence of the EA sovereign debt crisis (Moro, 2016). Trade links between both Europe and the USA and within Europe facilitated the propagation of the Subprime crisis to Europe (European Commission, 2009).…”