Eurozone can be saved in three steps

Europe’s leaders need to follow just three steps to secure the stability of the beleaguered eurozone, Giles Keating, head of global research at Credit Suisse Zurich, told delegates at the Association of the Luxembourg Fund Industry’s (Alfi) November conference.

Keating said the intensifying pressure on European banks is what keeps him awake at night.

It’s not just because German banks that will not lend to Greek or Italian banks, he said, but because international depositors (particularly US mutual funds) will no longer renew their large deposits with European banks and even AAA-rated countries are experiencing withdrawals.

Although the long-term impact of this is not instantly foreseable, he praised the European Central Bank (ECB) for “acting in a very responsible and partially effective way to lend to EU banks to make up for these deposit withdrawals both in euros and via a swap line with the fed in dollars.”

Yet despite the ECB’s best efforts, the “European banks are under pressure, are starting to shrink their balance sheets and are doing it faster than was ever really intended by the regulatory push,” Keating noted.

This poses the risk of a credit squeeze not just within the eurozone but also around the world, Keating argued. For example, French banks are among the largest providers of fresh credit in Asia.

The first of the three steps needed to combat the European banking crisis is for Portugal, Italy, Spain and Greece to “raise taxes and cut spending, privatise assets as a way of reducing debt without squeezing their economies too much and undergo reform to remove red tape,” Keating said.

The second step involves providing support to Europe’s struggling banks. The ECB has already made some headway in this respect having provided temporary liquidity to Europe’s banks in the face of heavy investor withdrawals, Keating argued.

Greek banks have now been lent approximately €121bn by the ECB, Italian banks €100bn while the French banks have seen a rapid escalation in their borrowing from the ECB, now reaching €140bn. “I have every expectation that this figure will get higher,” he added.

The final area to be addressed is the European bond market which needs to be stabilised, Keating concluded.

This could be achieved with the help of the European Financial Stability Facility (EFSF) and its potential successor, the European Stability Mechanism, although this is being hindered by the ECB making a series of “cautious purchases on a limited scale,” he added.

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