73–84. Decressin, J. and A. Fatas (1995), “Regional Labour Market Dynamics in Europe”, European Economic Review, Vol. 39: pp. 1627–1655 De Grauwe, P. (2000), “The Economics of Monetary Union”, 4th ed., Oxford University Press, Oxford. De Grauwe, P. and F. Mongelli (2005), “Endogeneities of Optimum Currency Areas: What Brings Countries Sharing a Single Currency Closer Together?”, ECB Working Paper No.468, Apr. Delors Committee: Committee for the Study of Economic and Monetary Union (1989), “Report on Economic and Monetary Union in the European Community”, Luxembourg: Office for Official Publications of the European Communities. Frankel, J. (2008), “The Estimated Effects of the Euro on Trade: Why Are They Below Historical Effects of Monetary Unions Among Smaller Countries?”, NBER working paper 14542. Frankel, J. and Rose, A. (1998), “The Endogeneity of Optimum Currency Areas Criteria”, The Economic Journal, Vol. 108, Jul, pp. 1009–1025. Frankel, J. and Rose, A. (2002), “An Estimate of the Effect of Common Currencies on Trade and Income”, Quarterly Journal of Economics, 117, pp. 437–466. BIS central bankers’ speeches  9  HM Treasury (2003), “UK membership of the single currency – an assessment of the five economic tests”, CM 5776, London, HMSO, Jun. Kenen, P (1969), “The Theory of Optimum Currency Areas: An Eclectic View,” in Robert Mundell and Alexander Swoboda (eds), Monetary Problems of the International Economy, Chicago: University of Chicago Press, pp.41–60. Krugman, Paul R. (1992) “Policy Problems of a Monetary Union”, pp. 185 – 203 in Krugman, Paul R. (1992) Currencies and Crises (Cambridge Ma, and London: MIT Press).

BIS central bankers’ speeches  5  middle of 2012 (chart 5). Bank lending to the real economy collapsed and credit conditions tightened massively (see charts 6–7).20, 21 Clearly something must be done. It is in the interests of all countries to sever the link between banks and sovereigns by ending too big to fail. Governments must put in place regimes that impose losses on bank management, shareholders and creditors rather than taxpayers. That is exactly what is established by the UK’s recent Banking Reform Act, and the recently agreed European Bank Resolution and Recovery Directive. The Bank of England is at the forefront of efforts to establish the common global requirement that is needed to finish the job. While ending too big to fail should mean that taxpayers no longer have to bail out banks, it will not fully break the bank-sovereign loop, for three reasons. First, banks hold substantial amounts of their national government’s debt in order to manage liquidity, meet collateral obligations and hedge exposures – European banks hold more than € of home country sovereign debt amounting to 5% of total assets. Second, confidence in deposit guarantee schemes relies on a national backstop.22 The European process illustrates the difficulty of building the institutional arrangements for a common insurance scheme across sovereign states. This is unsurprising since mutualised deposit guarantee schemes imply a pooling of risk and loss of sovereignty. All member states must be persuaded that they won’t simply be left with the bill for the mistakes of others.