Bringing Stability to Europe: Why Europe needs a banking union

Abstract:

The European sovereign debt crisis is the result of capital flows across the single market.

The danger that such capital flows could unleash market speculation was known from the start; indeed, the single currency was created to remove the threat of exchange rate instability.

The problem is that the architects of the single currency did not consider the impact of capital market integration on the banking sector or on the relationship between banks and national governments.

Once markets lost confidence in the security of their cross-border investments, investors began to pull back their capital and the internal market for financial services started to disintegrate.

The creation of a banking union is part of the solution. However, the euro area also needs a common ‘risk-free’ asset to use as a safe haven in times of crisis.