Comment: Regulation and Austerity Are a Toxic Mix

Rising regulation and economic austerity could produce a toxic mix in 2011. That was the view of many of the bankers that I spoke to last week at the International Institute of Finance spring meeting in Vienna.

Rather predictably, they were more concerned about the prospect of a regulatory recession than one induced by governments taking the axe to spending.

The Institute's Chairman, Joseph Ackerman, indicated that he thinks that if Basel III is implemented in its current form, then gross domestic product estimates will need to be slashed and job queues will be dramatically extended.

Now, there could be some truth to this. After all, Europe does rely on its banks as the main providers of credit. Consequently, an increase in capital requirements may produce a reduction in lending.

However, a more significant threat is one the bankers in Vienna understandably didn't seem to want to talk about. This is the issue of the quality of their businesses. As rising inter-bank lending rates indicate, financials in Europe increasingly no longer trust one another.

The obvious antidote to this situation is the publishing of the results of detailed stress tests that are in the final stages of being conducted by the ECB.

The problem is that the region's finance ministers, as the Austrian Finance Minister made clear to me, simply won't publish the findings at an individual level. They are quite happy to give us a general top down picture but not a detailed bottom up view.

The question has to be: what are they afraid of? Surely by now they must understand that if they don’t publish, the market will simply assume the worst even if Moody’s says there is no problem.

That leads us to the conclusion that the Finance Ministers have realized that the situation is even worse than the ‘worst case scenario’ that investors are talking about and that bailing out the banks on such a massive scale will be politically impossible.

In this case it's probably prudent to assume that at some point in the not to distant future Europe is going to have another major banking crisis.

The question then is: what will be the catalyst? The bankers could be right; it could be the impact of regulation. However, this seems unlikely. The more obvious spark is the default of Greece or some kind of debt restructuring by Athens.

However, here again Europe’s leaders say that they have done all they can. In the words of European Central Bank President Jean-Claude Trichet, the scale of the political response has been commensurate with the size of the problem, even if the market does not recognize this.

This means that in the final analysis all our political leaders can now do is cross their fingers. All the arrows have been fired and the quiver is now empty.

  • Video - Trichet to Bankers: We Won't Bail You out Twice