Euro Area Bank Bailout Policies After the Global Financial Crisis Sowed Seeds of the Next Crisis

Viral Acharya
By Viral Acharya, Lea Borchert, Maximilian Jager and Sascha Steffen
During the 2008/09 global financial crisis, European governments bailed out a large number of banks that were severely affected by the crisis. This column documents how the design of the bailout policy was determined by the fiscal capacity of the respective country. Fiscally weak countries recapitalised banks insufficiently, causing undercapitalised banks to shift their assets from loans to risky sovereign debt and engage in zombie lending, resulting in weaker overall credit supply, elevated risk in the banking sector, and, eventually, greater reliance on liquidity support from the ECB. Kicking the can down the road in 2008/09 thus sowed the seeds of the future banking crisis. These results have potential implications for the ongoing COVID-19 pandemic as, if the economic situation further deteriorates, banking sector stability is likely to be adversely affected.

When considering interventions in the banking sector during crises, governments can either use system-wide or bank-specific measures (Farhi and Tirole 2012). Bank-specific measures can be grouped into three categories (Pazarbasioglu et al. 2011) – (1) guarantees, (2) capital injections, and (3) asset restructuring/resolution – the implementation of which induces different fiscal costs (Stavrakeva 2020).

In a new paper (Acharya et al., 2020), we investigate government interventions in the context of the global financial crisis using a novel, hand-collected dataset of all aid measures granted to euro area banks during the 2007 to 2009 period. While banks across all European countries were in distress, bailout decisions were subject to the discretion and the fiscal constraints of national governments. Key measures of fiscal capacity (inversely, constraints) are, among others, government revenues (as percentage of GDP) and the total debt of the country (as percentage of GDP).

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Viral Acharya is the C.V. Starr Professor of Economics