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Europe’s Fitful Financial Integration

LONDON – The well-publicized troubles of Portugal’s Banco Espírito Santo this summer have reminded us that the eurozone’s financial problems are by no means resolved. There are, no doubt, idiosyncratic factors behind the bank’s problems, stemming from its exposure to other parts of the Espírito Santo family’s empire. But when the bank announced a first-half loss of €3.6 billion ($4.7 billion), the sudden collapse of confidence was alarming, and nervous investors are asking whether there are similar time bombs ticking elsewhere.

All eyes are now on the European Central Bank’s asset quality review, due to be completed in the next couple of months. The AQR is the key element in a “comprehensive assessment” of Europe’s banks before the ECB formally takes on supervisory responsibility for more than 80% of the eurozone banking system in November.

The ECB, quite sensibly, wants all of the potential horrors to be visible before the takeover – so that it cannot be blamed. With national supervisors, who are often inclined to present a rosy picture of their countries’ institutions, no longer in charge, we can hope that the assessment will be more robust than the earlier stress tests carried out under the auspices of the European Banking Authority (EBA). Those tests, unlike their equivalent in the United States, failed to rebuild confidence. Several banks that passed with flying colors were soon obliged to raise new capital.

But the creation of the European banking union has not been the only important change to Europe’s financial regulation since the crisis. The events of 2007-2009 made it clear that there were serious gaps and inconsistencies that needed to be addressed. So, following the recommendations of a report prepared in 2009 by former IMF Managing Director Jacques de Larosière, the European Commission created three new pan-European authorities charged with ensuring “consistent application” of European directives.