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January 5, 2011 10:30 pm
On Thursday in Paris, European leaders are being brought together by the French government to discuss the year ahead. The top priority for the Group of 20 leading nations this year is to ensure a sustained global recovery that lays the foundations for stronger, sustainable growth. What does this mean for Europe? Addressing global economic imbalances cannot be code for a discussion between America and China, in which European countries are bystanders. On deficits, growth and banks, 2011 is the year Europe must put its own house in order.
This means confronting the difficult issues holding back confidence and growth. The first is continuing market concern about sovereign debt. The sense of crisis may have eased, but wide spreads and high market interest rates still stalk several European economies. We need a comprehensive package early this year to address this. The eurozone must follow the logic of the single currency and stand more convincingly behind the euro.
Action at a European level needs to be matched by difficult domestic decisions. The affirmation of the UK’s triple A credit rating, and the fall in our market interest rates, shows that it is possible to earn credibility with a convincing deficit reduction plan – as we saw this week as our plans began to take effect with the tough but necessary increases in value added tax to 20 per cent. But European economies also need both European Union and domestic measures to open up product markets, liberalise labour markets, support enterprise and reform welfare. That is certainly our focus in the UK as the next Budget approaches.
These measures alone will not be enough to restore sustainable growth without a credible plan to reform and strengthen Europe’s banks, the second difficult issue that must be confronted. Weak banks act as a brake on recovery. The inability of many European banks to absorb losses on their balance sheets was at the heart of the crisis and underpins much of the current market uncertainty.
In the short term we must ensure that banks have the support they need to withstand market concerns. This is precisely why Europe’s leaders agreed last month to new banking stress tests. It is revealing that the tests conducted last July identified a capital shortfall of just €3.5bn. Yet less than six months later, Irish banks required 10 times that amount. That is why the UK has already gone further with tougher stress tests that mean our banks are well capitalised.
Europe cannot repeat the same mistake again. It is now clear the new stress tests must be much tougher. They should cover a three-year period and look at liquidity as well as core tier 1 capital. We should look at ways of strengthening the credibility of these tests, including validation by bodies such as the International Monetary Fund. And where the tests show it to be necessary, banks must raise high-quality capital from either markets or, in extremis, national governments to secure their future.
For the longer term we need to strengthen Europe’s banks so that they, and not taxpayers, pick up the bill for future crises. Basel III contributes to this in several ways: increasing the quality and quantity of bank capital, as well as setting out a single definition that will underpin the single market; introducing new liquidity requirements; moving over time to a binding leverage ratio as a backstop to reduce funding risks; and ending the double-counting of the old regime for items such as insurance capital held by banking conglomerates.
Having agreed this balanced package with our international partners, it is vital that we insist on its implementation in the US and elsewhere, and that we do not weaken the measures as they are translated into European law. And we should do the same with the agreed G20 principles on bankers’ pay. Any talk of “European specificities” in Basel III that are not already accounted for, and any delay to the agreed timetable, will simply reaffirm markets’ suspicion that we are failing to address the difficult issues.
The goal of a stronger banking system is so important that we must not allow unnecessary distractions in other areas to get in the way of agreement. For example, restrictions on short-selling in sovereign debt markets have no basis in evidence and if agreed in their current form will only hamper market liquidity and force interest rates even higher. Nor should we allow badly thought through regulation needlessly to undermine European competitiveness in financial services. Talk of competition between London, Paris and Frankfurt misses the point. It is the relative competitiveness of Europe, with London as its major financial hub, against other centres in Asia and America that is the real issue. No one should doubt that Britain is determined to remain a global financial centre serving Europe and the world.
Finally, Europe must make its voice heard in the G20. Its presidency, under the leadership of Nicolas Sarkozy, French president, and my impressive counterpart Christine Lagarde gives us a great opportunity. We must reform the international monetary system, strengthen its institutions and expand free trade. If the political will is there we can keep our economies, and our banks, on the road to a sustainable recovery.
The writer is UK chancellor of the exchequer
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