Purging weak banks

Voices for censuring the weak financial institutions have become much louder since the eruption of banking crisis and the onset of global recession a few years ago. At a meeting of leading bankers and regulators at Frankfurt on 18th November, there was a general consensus that Europe needs to stop propping up ailing banks and also have the courage to tackle lenders viewed as "too big to fail". Deutsche Bank Chief told the audience attending the "Euro Finance Week" that "consolidation in Europe is overdue. We have too many banks that are holding back progress because we have kept them alive for too long". All the banks should be pressurised to find a successful long-term business model and those who don't succeed should be wound down in a sensible way. The European Union's Chief Regulator agreed that not enough of the region's 6,000-plus banks had been allowed to fail. Germany's banking regulator warned bankers that they should not assume that governments will step in to bail them out if they got into trouble. Hans-Dieter Brenner, the chief executive of Helaba, one of Germany's state-backed Landesbanks, said that he expected that the consolidation process will not be over in the medium-term and some of his rivals may disappear over the next few years.
Such a process or policy change in Europe was long overdue. Traditionally, financial institutions in Europe and some other countries have been kept alive despite their acute cash flow problems at a great cost to the government exchequer and ordinary taxpayers. This gave them a kind of licence to indulge in uncharted risky ventures and introduce new products that proved to be financially unviable later on. Banks, nonetheless, continued this practice, believing that government or the central bank would come to their rescue at the time of trouble. However, people in most countries are now running out of patience due to huge perks and privileges still enjoyed by top bankers and dwindling incomes and lack of employment opportunities for other people due to recessionary tendencies in most of the economies. More strict treatment meted out to the problem banks in USA has also encouraged the European regulators to be less supportive to their own banks. It is no secret that too few banks in Europe have been wound down and disappeared from the market so far. Their number was fewer than 40 compared to 500 in the United States. The reluctance to close a bank is generally due to the fact that, unlike an ordinary enterprise, failure of a bank can inflict a great loss on the economy due to its close linkages to various stakeholders including the financial system as a whole, other businesses, depositors etc. Lately, however, the realisation has grown that efforts to support the weak banks have stifled rather than promoted economic growth and consumed a lot of resources. This has added to the demand to purge weak banks. How to undertake the necessary exercise and implement such an action is, however, an important question. The central banks have certainly to be more proactive in such an undertaking and tell the financial institutions under their watch that monetary and fiscal authorities will not step in to bail them out if they get into trouble. Secondly, the regulatory regime has to be made more stringent in order to ensure that capital requirements and other obligations as specified under the Basle agreement are meticulously met to maintain the solvency of the banks. Proper stress tests need to be evolved to detect early warning signs. And thirdly, winding down of bank should not be treated as a catastrophe but regarded as an option for the smooth and efficient functioning of the financial system in the medium to long-term. However, before adopting such an option, the preferable course of action could be the consolidation or merger of weaker banks with the stronger players to maintain the confidence of public in the soundness of the system.