Now, rather than worrying about the meaningless bank capital numbers and socializing the banks' losses, the finance ministers can worry about requiring the banks to perform their role as the safety valve between financial market excesses and the real economy.
The bank safety valve function is their ability to absorb unlimited amounts of losses. They can absorb the losses necessary to restructure the debt to a level where the borrowers can afford to service their debt.
By reducing debt payments to what the borrowers can afford, banks re-establish the conditions for economic growth.
European Union finance ministers failed to agree on Tuesday how to shore up sagging banks and avert a credit squeeze, as rising borrowing costs for Italy threaten to unleash a new and more dangerous phase of the euro zone debt crisis.
Against the worsening economic backdrop, European banks are finding it hard to borrow and are increasingly reluctant to lend to one another.The solution to this problem is to require each bank to provide disclosure of its current asset, liability and off-balance sheet exposure details. This would unfreeze the interbank lending market as lenders would know exactly what was happening at the borrowers.
In an attempt to arrest this creeping credit freeze, ministers examined offering state guarantees to borrower banks on Tuesday but became bogged down in deciding whether to pool such guarantees in Europe or ask countries to go it alone.
"The point is to what extent you pool together guarantees for banks," said one official. "There are differences of views on that point."
Austria's finance minister and others said two schemes were now being considered -- one a common "harmonized" model of guarantees for banks that need to borrow and another a "consortium" where state guarantees for banks are gathered....Rather than guarantee interbank loans, the guarantee should be saved for deposits. So long as the depositors feel that their funds are not at risk, they are willing to stay with a bank which is insolvent.
It is the deposit guarantee plus current detailed disclosure that makes it possible for the banks to absorb the losses related to credit excesses.
Michel Barnier, the EU official in charge of financial regulation, said he would write a law to empower supervisors to push banks that need to beef up their capital by curbing their dividend or bonus payouts....This law should be applied after the banks have absorbed the losses and restructured the debt.
Amid indecision, the EU's attempts to support its lenders may be overtaken by events.
Recapitalizing banks was in part intended to cope with a default by Greece. But if debt-ridden Italy -- the euro zone's third biggest economy -- were also to need financial assistance, the scale of the problem would change entirely.It is only the bank balance sheets that are large enough to absorb the losses.