Is Europe Overbanked?


This paper is after a difficult question: has banking grown too much in Europe? The difficultly of the question lies in the words “too much”, which require a normative answer. We must take a stance on how much is “too much”, based on the needs of the real economy in Europe.

To tackle the question, we take an approach similar to that of a doctor treating a patient who seems overweight. The doctor’s first step is anamnesis: to collect information about the patient’s current and past weight and their medical history; and to benchmark these data against those of other people. Likewise, in Section 1 we review basic facts about the banking system in Europe, including its size, recent growth, concentration and leverage, and compare these data with those of other banking systems. According to all indicators, our patient is abnormally heavy.

The doctor must then make a diagnosis: as to whether the patient has gained “too much” weight, in the sense of weight gain leading to problems such as high blood pressure, sleep and breathing difficulties, and so on. Similarly, in Section 2 we explore whether the European banking system has expanded beyond the point where it makes positive contributions (at the margin) to the real economy. Specifically, we investigate whether banks’ recent expansion is associated with (i) lower and more volatile economic growth; and (ii) excessive risk-taking and more frequent financial crises, including banking and sovereign debt crises.

At this point, the doctor considers why the patient has gained so much weight, i.e. turns to etiology: is it eating disorders, a sedentary lifestyle, or a disease? This question is asked not just out of curiosity, but because these causes entail different prognoses regarding the future of the patient’s health and different therapies. Similarly, Europe’s overbanking problem reflects various causes (described in Section 3): (i) government support and inadequate prudential supervision have exacerbated banks’ moral hazard problems; (ii) politicians in some countries have encouraged such expansion, for instance to promote “national champions” or to stimulate employment growth for electoral reasons; and (iii) the cost mix of European banks may have induced banks to overextend their market presence.

Finally, after gathering and evaluating all the evidence, the doctor prescribes therapies for the sorry patient. The objective of therapy is to address the root causes of the illness; alleviate nasty symptoms; and avoid unintended side-effects. Likewise, in Section 4, we outline possible policies to address overbanking in Europe.

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