Challenges of the EU Financial Systemafter the Sub-Prime Crisis
KEISUKE AOKI†

Abstract
Triggered by the failure of Lehman Brothers in fall, 2008, a
global financial crisis attacked the European countries. In this thesis,
we argue about challenges of the EU financial system exposed by thisfinancial crisis and problems of conventional growth strategy for theEuropean countries.
Though the authority to supervise financial institutions and tocarry out a fiscal policy are entrusted to each country in the EU, a financial policy such as liquidity provision and adjusting interest rates
is enforced unitarily by the ECB. As a result, when financial institutions doing business for borderless in the EU faced a crisis, various
problems occur when they practice prompt crisis countermeasures.
That causes one of factors letting the EU financial system non−stabilize.
JEL classification: E 42, E 44, E 52, E 58, F 33, F 36!. Introduction: Background and Process of Monetary Crisis in 2008
The issue of subprime loan in U.S.A. which had come to the front insummer, 2007 caused an unprecedented monetary crisis in 2008. As for†

School of Economics, University of Nagasaki. Comments are welcome. Email: aoki@sun.ac.

jp

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the beginning, the delay of the interest payment or the default of the homeloan by the burst of the U.S. house bubble had let the value of financial instruments securitized subprime loans fall, therefore the management of financial institutions and investment firms holding them turned worse. After
that, the influence produced suspicion fear in the whole monetary system
and it developed into a global monetary crisis. The process which led to
the global monetary crisis seems to have three main routes.
First, it is the short-term money market which financial institutions
daily use to finance from each other. The short-term money market had amalfunction and became paralysis as money supplier remarkably decreased
because of mutual credit uncertainty of financial institutions and investors.
That caused from the aggravation of financing for financial institutions
which suffered a financial loss and turned worse their management. Therefore the sound financial institutions not holding securities related to subprime loan became difficult to finance, and many of them faced to a liquidity crisis.
Secondly, the value of other securitized instruments with no related tosubprime loan fell, and appraisal loss of financial institutions, investmentcompanies and general companies holding those instruments spread andthe loss in weight of their assets value caused serious management difficulty. Moreover, the risk of other loan credit covered with some financial
instruments like CDS (credit defaults swap１) suddenly increased because ofmanagement uneasiness of insurance companies or investment banks.
They sell CDS and undertake original risks. That also brought credit uncertainty of financial institutions holding such loan credit.
１

CDS is a credit derivative contract between two counter parties. The buyer makes periodic
payments (premium leg) to the seller, and in return receives a payoff (protection or default leg)
if underlying financial instruments or firms default.

６４Challenges of the EU Financial System after the Sub-Prime Crisis

The final route is below. Because of such financial uncertainty, thevalue of derivatives and any other financial assets such as stocks, corporate
bonds, investment funds fell. Besides instruments related subprime or
CDS, the decreasing value of various financial instruments caused deterioration of functions of the whole capital markets. The financial panic thatspread through these three routes developed into a serious global financial
crisis before long.
Financial institutions and investment companies in Europe were holding big amount of securitized financial instruments related subprime loans.
There were some signs since before this problem came to the front greatly
in summer, 2007. In February, 2007, the UBS in Switzerland closed theirsubsidiary hedge fund, Dillon, Read & Co. because of the loss of subprime-related instruments. In July, IKB in Germany filed for a rescue fund to
KfW２ because of the same loss. In August, BNP Paribas in France suspended operations of three of its funds. In this phase, the European Central Bank (ECB) injected cash into the financial system. The ECB lent 95
billion euros to meet banks’ needs after demand for cash in the European
money markets. In September, Northern Rock Bank in U.K. faced a runon the bank. This bank did not hold subprime related instruments much,
but the home loan ratio for their business profit was high, and it was highly
dependent on the short-term money market for the fund. Northern RockBank was eventually taken into state ownership in February, 2008. This
event appeared that subprime loan issue was widely regarded as the serious
problem for general people and society. However, at this point, it was stillthought that every government of each country and each central bank could
handle such financial problems individually.

２

Refer to http://www.kfw.de/EN_Home/index.jsp.

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It was September, 2008 that the situation changed completely. A start
was the failure of Lehman Brothers, a U.S. major investment bank. (They
filed for Chapter 11, bankruptcy protection on September 15.) That reduced the value of securitized instruments, corporate bonds, stocks and so
on greatly. Their creditor and partner financial institutions which had dealt
with them for derivative business like CDS suffered a big loss. On the following day, September 16, the U.S. government announced to inject a rescue fund to AIG, a U.S. major insurance company, of which the management uneasiness had been worried. In this way, the monetary crisis originated in the U.S. has become serious. The U.S. government announced
Emergency Economic Stabilization Act of 2008 to purchase from financial
institutions a large amount of bad loans on September 19 and appealed toother countries for the same action, but most of European countries, suchas Germany and France showed negative reactions. However, at the end of
September, the crisis for the failure of financial institutions began inEurope as well. The governments of Benelux announced to inject capitalfor Fortis, a financial service company, based in Belgium and the Netherlands. After that, in U.K., Ireland and Germany, one after another financial
institutions were nationalized or were injected public funds. (see Table 1.)
That these financial institutions were driven into the failure wascaused mainly a malfunction of the short-term money market, the firstroute mentioned above. The counter party risk was strongly realized by
the failure of Lehman Brothers, and it exerted serious influence on the finance environment of the financial institutions. They always doubt which
financial institution made the loss, how much loss they had, when they will
fail. In addition, doubts that the financial institutions related with Lehman
Brothers might have massive loss made LIBOR raise rapidly, and most ofEuropean financial institutions faced the situation they could not get dollar
６６Challenges of the EU Financial System after the Sub-Prime Crisis

for daily settlement. (see Figure 1.) This influence extended to the transactions in euro and pound. To break this situation, on September 18, each
European central bank made swap agreements with FRB and supplied dollar liquidity, but it did not change. Financial institutions which had high financing ratio from the short-term money market or had much bad loans
fell into a more serious situation３.
Under this situation, the ECB supplied big amount of liquidity, but at
the same time, both lending and deposit facilities were increased. (see Figure 2.) This means that financial institutions which faced difficulty for financing could not finance at the short-term money market. Besides, financial institutions of which the funds were in surplus were dealing with only
the ECB, though the deposit facility rate was lower than the market rate.
For the financial institutions facing a serious situation, their mutual meansof financing were not available. Those institutions having been exposed to
the risk of financing failure, it is found that the short-term money market
did not function and was falling into paralysis.
Table 1. Trend of Monetary Crisis since mid-September
EuropeThe U.S.
・U.S. government, GSE support plan
Sep.07.
release
Sep.15. ・Lehman Brothers failure
Sep.16. ・FRB, bailout for AIG releaseSep.18. ・U.K. Lloyds TSB, takeover HBOS

Sep.18.

・FRB, dollar swap agreement with
BOJ, ECB, BOE etc
・FRB, emergency loan for MMMF

Sep.19. ・U.S. government, Emergency Economic Stabilization Act of 2008 release
Sep.21.

・Goldman Sachs, Morgan Stanley become traditional bank holding companies

３

Fortis was worried for ABN AMRO holding assets deterioration. As for Hypo Real Estate,Depfa Bank faced difficulty for its financing from the markets.

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Sep.28.

Sep.29.

第４３巻第４号（２０１０年）

Sep.24.

・FRB, spread swap line for each central bank

Sep.25.

・Washington Mutual forced to close
by FDIC・Benelux, Total 11.2 bn euros to Fortis capital injection
・U.K., Bradford & Bingley (B&B) nationalized, takeover by Spain Banco
Santander・lower House, Emergency Economic
Stabilization Act of 2008 reject・Iceland, Glitnir Banki nationalized,
75% stocks for 600 million euros

・FRB, TAF loans spread

・Germany, Hypo Real Estate 35 bn Sep.29. ・FRB, swap line agreement with ceneuros credit line from the governtral banks of Northern Europe andment & consortium of German banks.
Australia
・Dexia, 64 bn euro as capital injection
by France・Belgium・Luxembourg
Sep.30.
government & large stockholder

・CITI, takeover Wachovia release!(After that, purchased by Wells Fargo)

・Ireland, Deposit full guarantee(Domestic main 6 banks only)

Oct.02.

Oct.03.

Oct.01.

・Senate, amended Emergency Economic Stabilization Act 2008 approve

・U.K. FSA, Deposit guarantee upper
Oct.03.
limit spread・lower House, amended Emergency
Economic Stabilization Act 2008 approve

・Greece, Deposit guarantee upper
limit spread (for all domestic banks)・ECB Executive Board, consider reduction in interest.

・G 4(G・F・I・U.K.)emergency summit,
reject rescue funds plan proposed by
FranceOct.04.

・Hypo Real Estate,credit line spread
up to 50 bn euros
・German, Personal deposit guarantee
upper limit spread
・Sweden, Deposit guarantee upper
・PWG, appeal heeds for international
Oct.06.
limit spreadcooperation for the crisis

Oct.06.

・BNP Paribas, takeover Fortis’s Belgium, Luxembourg section
・Iceland, Act Providing for Special
Powers in Exceptional Financial
Market Circumstances approve!S&P,
Iceland demote (A- to BBB)

Oct.07.

６
８・EU Finance Ministers’ meeting, De・IMF, total loss of financial instituposit guarantee upper limit spread,tions estimate 1400 bn dollars inshelve rescue funds plan!
Oct.07.
Global Financial Stability Report!
・Spain, Greece, Austria, Netherlands,(amount changed to 2200 bn dollars
Deposit guarantee upper limit spreadin Jan. 2009.)

Challenges of the EU Financial System after the Sub-Prime Crisis

・Spain, funds for purchasing assets offinancial farms plan (up to 30〜50
bn euros)

・FRB, announce creation of Commercial Paper Funding Facility (CPFF)

・Iceland, Landsbanki under official
management

・Bernanke FRB Chairman, suggest reduction in interest rate

・Iceland, shift to fixed exchange rate
system (renounced)
・Austria, Personal deposit full guaran・Paulson, suggest public funds to FiOct.08.
teenancial institutions
・U.K., 20 bn pounds of capital injection for main banks. (max 50 bn
pounds) 250 bn pounds of government guarantee for financial Institutions
Oct.08.

・FRB・ECB・BOE・Canada・Sweden・Swiss CBs cooperation reduction in interest
rate. BOJ strongly support
・Iceland, Kaupthing under official
management
・Italy, rescue plan for financial institutions release
・ECB, spread between lending anddeposit facilities reduce 50 bp

Oct.09.

・ECB, supply bid amount of money atthe operations

Oct.10.

・G 7, action plan including capital injection by the governments

Oct.12.

・Summit of the euro area countries,“concerted European action plan”
・Germany, France etc, plan for the in・U.S government, preferred stock of
jection of public funds and guarantee Oct.13.
main banks acquisitionof banks debt

Oct.13.

・ECB・EOE・Swiss bank, increase
currency swap with FRB and supply
necessary total amount of dollar bid
・U.K., injection of public funds to 3
domestic main banks

Source: News, each government, central bank announcement.

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Figure 1. Transition of LIBOR (U.S. dollar)
9/30

（％）
6.5

9/16
10/8

5.5
LIBOR In U.S. dollar overnight
LIBOR two weeks
LIBOR three months
FF rate

4.5
3.5
2.5
1.5
7/10

7/25

8/9

8/24

9/8

9/23

10/8

Source: Bloomberg

Figure 2. ECB Open Market Operations and Facility
Amounts of Outstanding
Billion euros

160
140
120
100
80
60
40
20
0

Million euros
Lending Facility

750
700

Deposit Facility

650Open Market Operations (right)

600
550
500
450
400
9/1

9/5

9/11

9/17

9/23

9/29

10/3

10/9

Source: ECB". Problems of EU Financial Supervision and Crisis Management Ability!

Deposit Guarantee and Failure Scheme
In this financial crisis, it was exposed that the authority of the ECB

was insufficient for the correspondence in the emergency. The ECB has
７０Challenges of the EU Financial System after the Sub-Prime Crisis

the authority to supply currency and to interest rate policy, but does nothave one for the supervision to financial institutions, the judgment of theirfailure, the deposit guarantee, the protection for functions in the interbank
money market and the injection of public funds. Therefore, in the crisis
extending over countries, we found it difficult for the ECB to manage orcontrol those matters. As the authority mentioned above belongs to thesovereignty of each country, in this crisis, each country announced andexecuted its own policies one after another; as a result, it can not be denied
that the financial market was made even more confused.
The confusion seen in the EU, above all, was the deposit guarantee
policy in each country. First of all, it was Ireland. Though they had EU
common Deposit Guarantee Scheme (Directive 94/19/EC) in the EU, theIreland government announced its own policy, a 100% deposit guarantee,
but covering only 6 domestic main banks on September, 30. ４ AS thisscheme was not applied to non-Irish-owned institutions, in U.K. which is aneighboring country and historically has strong economic linkage with Ireland, a large amount of deposit flew out to Irish-owned institutions from U.
K.-owned. The U.K. government demanded the withdrawal from the Irish
government, but they rejected it because of maintaining their own financial
system. They said, under the present condition that the EU as a whole did
not possess effective measures, a small country like Ireland had to deal
with the problems itself.５ After that, in Greece, successively in U.K. andGermany, the governments announced to increase an amount or the deposit

４

In the EU before the crisis, under the EU Deposit Guarantee Scheme 1994 (Directive 94/19/
EC), the minimum amount was 20,000 euros, and it covered all institutions in the EU. About
70% of the EU countries set 20,000〜25,000 euros. Ireland was in a 20,000 euros
group. Britain set about 33,000 pounds in total (deposit guarantee and insurance). In this way,
the amount was different from each country.
５
Refer to Financial Times (Oct’, 2, 2008.)

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full guarantee in order not to flow out the deposit from own countries.
Their correspondence like this showed that the EU as a common framework did not function enough in it. On October, 4, EU an emergency summit (of 4 main countries, U.K., France, Germany and Italy) was held, andthey agreed every EU country would cooperate in dealing with this financial crisis. However, in the Council of Economics and Finance Ministers(ECOFIN) held on October, 7, they agreed to raise an amount of the deposit guarantee and to establish the framework of EU cross-border supervision for financial institutions, but public intervention to relieve the institutions still remained to be decided at national level, not at the EU level. In
this council, they also agreed to provide deposit guarantee protection for an
amount of at least 50,000 euros, for an initial period of at least one year.
But some countries determined to raise their minimum to 100,000 euros,
so there is still big difference among member states.６
In the EU, it is difficult to construct cross-border scheme for bankfailure throughout all the EU countries. The European Commission had
been calling for a coordinated approach to addressing the crisis, but in theabsence of any agreement, individual governments were introducing theirown measures to rescue banks from collapse. That is the problem. In thisEU-wide deposit guarantee scheme, they set a minimum amount of guarantee, but other articles belong to discretion of each country. Therefore,
the contents of each deposit guarantee scheme practically have various differences. If there is absence of the EU common framework and consistency in the scheme, the difference of protection by the scheme effects
ability to compete of financial institutions, moreover, it may be happened
the problem that some deposit will be expelled from the deposit guarantee

６７２

E.g. in Spain and Italy, they guarantee around 100,000 euros.

Challenges of the EU Financial System after the Sub-Prime Crisis

scheme. The reason why a large amount of deposit flew out from U.K.owned institutions this time, as a result of the guarantee scheme the Irish
government carried out, is exactly the absence of this consistency.
In the condition like EU that financial institutions can do business inborderless, deterioration or failure of the institution in a country is contagious to other countries, so that financial systems in several countries may
be damaged at the same time. At this point, the authority of financial supervision is decentralized in each country, once happens a failure of the institution in one country, which country has the main authority to supervise
is unclear, then, it might be said to select the scheme for the settlement will
be hard task. If the injection of public funds is needed, to spend home tax
to rescue foreign financial institutions may be the problem. If the money
for rescuing the foreign financial institutions from collapse originallycomes from funds mostly accumulated by the home institutions, this casemay be one also.
The most of the cases for addressing failure of financial institutions
are held by the following ways such as the business transfer, M&A, P&A
and nationalization. The government or the Deposit Insurance Corporation
usually supports funds or capital. The method of payoff or bankrupt is seldom chosen for that. Moreover, if the bank is very big and has an international presence, those methods are hardly adopted because the influence or
damage to depositors, firms and the financial system is big and rather costs
too much. It is what is called the too-big-to fail problem.
When the case of addressing like this is taken, there is a problem,“Who bears the cost?” When such a case is necessary, there seems to be atacit premise that the head office located country basically bears the cost.
But, if the relief funds are tax, it is expected that repulsion is caused
against using home tax for foreign depositors. In this case, a burden
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scheme might need to be settled in advance. For instance, related countries
share the cost in proportion to the deposit balance. Starting of the procedure for addressing failure also needs to be settled as a common scheme in
the EU. Though financial institutions have to obey the supervision of theauthorities in every country, the participation of the authorities is essential
for addressing failure also. The right of the procedure statement for failure
is given not only to the financial institution concerned but to the supervisory authority in Japan, however, in Germany, it is given only to the supervisory authority, and it is to perform the judgment of addressing failure. If
a bank has reached failure in that case, the responsibility of the supervisory
authority may be asked.７ In France, the veto for starting procedure of thebankruptcy is given to the supervisory authority. Thus there are several
kinds of proceeding and each procedure is different in different countries.
It may be to cause confusion.
!

Prompt and Appropriate Measures in Coordinated Framework
After the outbreak of the crisis, a prompt public fund injection was

carried out for Fortis and Dexia, both the mid-scale banks, in the end of
September, and both banks were relieved. These banks could get a prompt
bailout because their business had been performed fortunately within Netherland, Belgium and Luxemburg which have a historically close relationship among them. But it is uncertain whether such coordinated measures
are taken after this in the EU. Through this crisis, under the present condition that each country in the EU has its own authority of financial supervision, it has become clear that taking coordinated action for a bailout of fi７

In the case of Northern Rock in Britain, the report accusing FSA of improper supervision
was submitted to the Parliament.(House of Commons, Treasury Committee, “The run on theRock”)。

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Challenges of the EU Financial System after the Sub-Prime Crisis

nancial institutions such as injection of public fund in order to stabilize thefinancial system. As the cause, a structural problem of the EU is pointed
out. That is, “independent fiscal policy of each country and single monetary policy of the ECB”.
At first about the fiscal policy, under the present condition that the EU
does not have a common appropriate scheme, each government has to address for too-big-to fail institutions. However, when the government faces
the case to rescue the huge institution in comparison with its economic
scale, a limit may come in their fiscal burden. For instance, Fortis, as
stated above, had 254% of GDP in assets. Dexia had 173%. They were
saved, but had huge assets.８ If the necessary funds for injection swell, andthe limit comes, there is risk to spread uneasiness about the financial system to all the EU. When we considered ability for fiscal burden of eachcountry, the size of the present budget deficit of each country deserves
anxiety. The budget deficits of main countries of the euro area are as follows, Germany -0.2%, France -2.7%, Italy -1.6. (of GDP, 2007.) The
worst is -3.5% of Greece, which breaches the SGP criteria. When basedon the situation after the crisis, further deficit expansion will be expected
in many countries after 2008.
Besides, in the euro area, each risk of every country begins to be conscious of in the government bond market. Each interest rate of the government bonds in the euro area, a common currency zone, converged on therate of the German government bond as an anchor. Each spread between
two countries, Germany and others, had begun to rise slowly after around
March, 2008 when financial uneasiness focused, and has showed a rapid
expanse since September. (see Figure 3.) The one, especially between

８

Refer to Financial Times (Sep’, 30, 2008.), “Are European banks too big to fail?”

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Germany and Greece, has indicated more than 200 bp since December,2008. In this way, even if each country carries out an independent bailout
toward the relief of the financial institutions, we cannot but say uncertain
whether each country can perform its independent measures to address thecrisis enough under the present conditions.
Figure 3. Long term government bond yields (10 years) and spread

Note: The spread is the difference between Germany and Greece.
Source:Eurostat

The policy of the ECB for the financial crisis was not executed at theearly stage of it. The ECB announced that they were considering both tomaintain and to lower the interest rate at the Governing Council held on
October, 2, and also announced they worried about losing the confidenceof the ECB if they had changed their policy other than the risk evaluation
to the prices stability. Judging from these remarks, it is supposed that the
ECB had no intention of wiping away uneasiness of the financial system
yet at that time. Facing to the further surge of the financial uneasiness andthe sudden fall of the assets prices such as the stock prices, the situation
took a sudden turn and the ECB carried out a concerted reduction in interest rates with five other central banks on October, 8. When the Danish
central bank raised interest rates to maintain the ERM 2 range (±2.25%)
７
６

Challenges of the EU Financial System after the Sub-Prime Crisison the previous day, they announced it was the decision with intention ofboth the difference in interest rates for the euro area and the stability of theexchange rate of the Danish kroner. Thus, it is the decision on having discussed with the ECB beforehand, and it seems that the ECB did not examine the reduction in interest rates till then. The concerted reduction in interest rates of 8th can be said to have been the turning point to the antifinancial crisis measure of the ECB. After the reduction in interest rates of
the ECB, the Danish central bank also withdrew the rise in interest rates ofthe day before.
The stock prices fell in spite of the reduction in interest rates of 8 th,
and the paralysis of the short-term money market was not improved. The
wiping off of the financial uneasiness by the reduction in interest rates has
little hope after all, and stronger recognition to the need for the injection of
public funds instead. As mentioned above, because the authority of financial supervision is decentralized in each country and of the difficulty of
executing a single monetary policy to a particular country, it is not easy tocarry out prompt fiscal and monetary policies in the euro area. Forestallingthe euro area countries, U.K. was the first to execute appropriate measures
for reliving financial institutions including the injection of public funds.
The U.K. government announced those measures several hours before theconcerted reduction in interest rates. Why U.K. could take such prompt
action can be said because both fiscal and monetary policies belong to the
only sovereignty.
The contents of the measures were as follows. The public credit line
was set for maximum 50 billion pounds. To prevent liquidity crisis, thegovernment guarantee of 250 billion pounds and the liquidity support by
the BOE were also provided. These guidelines were applied to all financial institutions in U.K. including foreign-affiliated financial institutions.
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This execution started other countries following.

Spain and Italy an-

nounced the foundation of the funds for purchasing the possession assetsof the financial institutions and other relief measures including the injection of the capital sequentially. On October, 12, the emergency summit of
the euro area countries was held and was adopted at last “a concentrated
European action plan of the euro area countries”. (see details in bellow.)
The remarkable points of the plan are to have enabled the injection ofprior preventive public funds to the financial institution and to give thegovernment guarantee to all financial institutions in the euro area including
subsidiary of foreign institutions in order to finance capital in the interbank
money market, moreover to ensure to take these appropriate action with all
euro area countries concerted and coordinated. It is hoped that the scheme
adopted this time will be fixed as a coordinated economic policy of thewhole euro area for the future financial crisis.

〈A Concerted European Action Plan of the Euro Area Countries〉
1. Ensuring appropriate liquidity conditions for financial institutions.
!ECB considering all ways and means to react flexibly to the current
market environment

2. Facilitating the funding of banks.
!The government guarantee is given to the interbank money market.
!The government guarantee is given to the new medium term (up to 5
years) bank senior debt issuance.

3. Providing financial institutions with additional capital resources so as tocontinue the proper financing of the economy.
７
８

Challenges of the EU Financial System after the Sub-Prime Crisis!Governments commit themselves to provide capital to financial institutions e.g. by acquiring preferred shares.

4. Allowing for an efficient recapitalization of distressed banks.
! To ensure that existing shareholders and management bear the due
and to execute appropriate restructuring plan.

5. Ensuring flexibility in the implementation of accounting rules given current exceptional market circumstance

6. Enhancing cooperation among European countries.

!. Challenges of the ECB Monetary Policy
After the declaration, a concentrated European action plan, of thesummit, the ECB carries out various measures to enhance the provision ofliquidity and prevents the influence of the financial crisis. They are also
strengthening the cooperation with the central banks of neighboring countries. Especially, to have set the credit lines for the Central and Eastern
European countries as a production foothold in the EU is an appropriate
measure. (see Table 2.)
In this way, the ECB has executed various measures for the financial
crisis since the concerted reduction in interest rates of October, 8. But
there are difficult problems for their policy administration. The first iscaused by the different economic structures of the euro area though it ispointed out whenever the monetary policy of the ECB is argued. The euroarea countries are all going to recession because of this crisis, but the individual situation is greatly different by a country. It is uncertain whether
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Table 2. The ECB liquidity measures and cooperation to peripheral
countries
The liquidity supporting measures to the Euro Area
・Reducing the corridor of standing facilities from 200 bp to 100 bp.
・The provision of liquidity equivalent to the collateral in regular bid.
・Expanding the swap arrangement with the FRB. Providing the U.S. dollar liquidity.
・Expanding eligible assets, marketable debt instruments dominated indollar, yen, and pound issued in the euro area.
・Accepting debt instruments traded on non-regulated markets, such as
CDs, subordinated bonds.
・Lowers the credit threshold for assets from A- to BBB- except ABS.
Cooperation with the central banks of peripheral countries
・ECB provides the MNB with a facility to borrow up to EUR 5 billion.
・Same to the Denmark Nationalbank with a facility to borrow up to EUR
120 billion.
・Same the NBP with a facility to borrow up EUR 10 billion.
・The reciprocal swap facility with the Swiss National bank. (swap line)
Source: ECB, each Central Banks.

Figure 4. The Risk Premium in the Interbank Markets
(bp)

350
euro (Euribor−OIS)

300

dollar (Libor−OIS)

250
200
150
100
50
0
07/7

07/10

Note: both 3 months rate.
Source: Bloomberg.

８
０

08/1

08/4

08/7

08/10

09/1

Challenges of the EU Financial System after the Sub-Prime Crisis

the policy of the ECB will be desirable for all the euro area countries. For
example, the economy in Germany has grown with exports and capital investments in recent years, but after this financial crisis, the external demand fell rapidly and it becomes the big cause of the German recession.
While in Spain, the housing market, is called the bubble, was shrinking
very fast, which causes their recession. What is worse, the unemployment
rate of Spain is much higher than that of Germany. And moreover, the debt
outstanding in both household and firms are greatly swelling because of
the recent boom of housings and constructions, and it is pointed out therisk that economy hovers around for a long term by the adjustment pressure of the balance sheet. Japan was in the same situation in 90’s. In theeuro area where labor movement is not always fluid, economy and the inflation rate difference of each country are not easy to converge, and the administration of the single monetary policy of the ECB may be going toface difficulty. Because the euro area countries are all falling into the recession, the monetary policy of the ECB will proceed to ease, but the single monetary policy for the countries where each degree of the recession isdifferent may cause the opposition among them. The ECB is pressed fordifficult steering.
The second problem is that an interest rate in the interbank market isconsiderably exceeding the policy rate, though the ECB has enforced alarge reduction in interest rates and executed the bold provision of liquidity
since October, 2008. Though it is the little less level compared to just after the crisis, the mutual suspicion among financial institutions is not yet
canceled, and the original functions of financing have not been restored. Ifsuch situation continues, the ECB may be enforced a policy to buy the assets of the financial institutions just like the FRB and the BOJ. Of course
it is possible for the ECB by the outright transaction of the open market
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operation, but on that occasion, it is necessary to examine that what kind of
method the ECB carries out, for countries having the different financial
characteristic. Various arguments are expected about their equitableness,
effectiveness and the real effect for economy. The main method is the outright purchases of the government bonds in the U.S. and Japan, but the
spread of the bond interest rate escalates by a country in the euro area as
had mentioned before, therefore the size of the risk is different from eachbond. In addition, the characteristics of the government bond market are
different in each country, moreover, what kind of assets, from which country, and by what kind of form does the ECB buy? The structural problemof the euro area is thrust on the ECB here again.
Various financial aid packages have been proposed in each EU country since October, 2008. The European Commission proposed 200 billion
euros (of GDP 1.2%) for economic measures, and is asking 170 billion
euros of the amount for each country. However, in fact, it is uncertain torealize because of fiscal reasons of individual countries. Over the capital
injection to financial institutions or direct aid packages of the government
to the medium or small-sized firms, there is still difference for correspondence between each country and the European Commission which is particular about the fair competition rule. In any case, the EU economy
caught the big damage by this financial crisis. It also brings great bad influence in the emerging countries of Central and Eastern Europe arguingwith the next paragraph, and is acting as a sudden brake on the economic
growth of these countries.
These small countries of the EU, inferior to potential abilities to get
rid of a crisis, are easy to be affected by the main EU country economies.
The stability of the financial system in the major country brings the stability of these emerging countries, and the economic recovery of the major
８２Challenges of the EU Financial System after the Sub-Prime Crisis

country also helps the recovery of emerging countries economy. The EU,
especially in the euro area, has the structural problem such as “the consistency between individual fiscal policies and single monetary policy”. Under the EU common scheme, it is necessary for every EU country to pursue
cooperated measures, and for the ECB simultaneously to provide sufficientliquidity and also to execute appropriate prudence policies.

!. Conclusion: The Outlook for the Future Crisis
The EU economic downturn has become clear because of the financial crisis of 2008. The real GDP of the third quarter fell by 0.2% both in
the EU 27 and in the euro area.

Actually, in the euro area, negative eco-nomic growth showed for 2 consecutive quarters, and it is the first time forthe euro area to put on record of 2 consecutive quarters since the introduction of the euro in 1999. Thus the euro area fell into a recession for the
first time. In the core countries, Germany and Italy showed -0.4% (08.Q 2),
and -0.5% (08.Q 3). Estonia and Latvia also fell into the recession. U.K.,
Spain, Hungary showed negative growth in 08.Q 3.９ With the further economic downturn, the unemployment rate remains high in main developed
countries, and even in emerging countries where the unemployment rate
has been low supported by the economic growth, it has begun to rise
gradually. With needs for measures to the sales slump and inventory accumulation, many companies are forced to production adjustment and it isvery difficult to predict the rapid recovery of the EU economy in the near
future.
This crisis let non-euro area countries currency of the EU drop sud９

According to Eurostat. (Jan’, 8, 2008.) Estonia and Latvia showed negative growth for 3
consecutive quarters since 08.Q 1.

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denly. One of the reasons is that investors or company managers whofeared against the small size central bank touched off a capital outflow.
The central banks of non-euro area opposed by raising interest rates butthat might have the side effect of eroding the domestic economy. With theintroduction of euro from January, 2009 near at hand, the confusion of thecurrency did not occur in Slovakia of which the own currency, koruna,
fixed to the euro. Even if it was a small country, the stability of the money
market could be secured as long as it was under affiliation of the euro. As
a result, Denmark and Sweden announced their early introduction of euro,
and Poland officially announced to aim the introduction of euro in 2012.
Even Hungary which fell into the critical situation in this crisis is turning
the stance of growth into an emergency response measure. In Czech, fromthe industrial world to the government, a voice in search of euro introduction rose.
This crisis unexpectedly has increased a unifying force to euro and it
seems to develop the way to further deepening of the EU. From now, in
addition to the precaution of a new financial crisis, the argument about the
expansion of the euro area will attract our attention as well.
References
Aydin, Brucu (2008), “Banking Structure and Credit Growth in Central and Eastern Europe
Countries,” IMF Working Paper WP/08/215, September.
BIS (2008), Annual Report.
European Union (2008), “European Union foreign direct investment yearbook 2008”.
European Union (2008), “European Economic Statistics 2008”.
IMF (2008), Global Financial Stability Report, October.
IMF (2008), Regional Economics Outlook (Europe”, October..
IMF (2008), World Economic Outlook, October.
JETRO (2008), “The influence of the financial crisis originated from the U.S. to economic andbusiness”, Research Reports, December.

８４Challenges of the EU Financial System after the Sub-Prime Crisis

Y. Nishimura (2008), “Does the global financial crisis really extend to Central and Eastern
Europe?” (in Japanese), International Economic and Financial Review (IIMA), November.
Mizuho Research Institute, all kinds of research papers.

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