Europe's plan to address weak banks risks unraveling

Fri Sep 27, 2013 2:19pm EDT
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By John O'Donnell and Eva Taylor

BRUSSELS/FRANKFURT (Reuters) - The European Central Bank's (ECB) plan to test the health of the euro zone's largest lenders without the means to plug any holes it uncovers risks foiling what some see as the bloc's final chance to put its financial crisis behind it.

Unlike in the United States, where rapid infusions of capital put its banks quickly back on track, Europe's financial system remains frozen, with lenders in countries such as Greece, Spain and Italy hurt by weak demand and soured loans.

To break the "doom loop" between indebted European countries and their banks and reassure investors that stressed euro zone lenders would be dealt with on a regional level, a banking union, with the ECB as supervisor, is viewed as crucial.

"The U.S. turned the leaf on its banking crisis in 2009," said Francesco Papadia, former head of the ECB's financial market operations, who helped guide the central bank's management of the financial crisis.

"Now the euro area has a great opportunity, probably the last one, to achieve this."

But the political will to forge full banking union has waned as the heat of the crisis has passed, and German reluctance to back a central fund that would potentially come to the rescue of any troubled euro zone bank means that the ECB is preparing to take on its role from late next year in a dangerous vacuum.

The ECB, both for its own reputation and the future of the bloc, is under pressure to ensure that banks undergo a thorough health check that will force them to recognize hidden losses.

But without a pan-euro-zone bailout fund, such tests could highlight problems without a convincing solution, potentially undermining the banking union project before it has fully taken off.   Continued...

European Central Bank (ECB) President Mario Draghi waits for the start of the European Parliament's Economic and Monetary Affairs Committee meeting in Brussels September 23, 2013. REUTERS/Yves Herman