De Grauwe and Ji: Strong Government, Weak Banks

Banks in the northern eurozone have capital ratios that are, on average, less than half of the capital ratios of banks in the eurozone’s periphery. We explain this by the fact that northern eurozone banks profit from the financial solidity of their governments and follow business strategies aimed at issuing too much subsidised debt. In doing so, they weaken their balance sheets and become more fragile – less able to withstand future shocks. Paradoxically, financially strong governments breed fragile banks. The opposite occurs in countries with financially weak governments. In these countries banks are forced to strengthen themselves because they are unable to rely on their governments. As a result they have significantly more capital and reserves than banks in the northern eurozone.

 

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