April 2009

IZA Policy Paper No. 2: The Transatlantic Banking Crisis: Lessons and EU Reforms

published as 'The Transatlantic Banking Crisis: Lessons, EU Reforms and G20 Issues' in: Paul J.J. Welfens and Cillian Ryan (eds.), Financial Market Integration and Growth: Structural Change and Economic Dynamics in the European Union, Springer, Heidelberg et al., 2011, 49 - 126

The key dynamics of the transatlantic banking crisis are analyzed – with emphasis on the fact that the banking disaster of 2007/08 was not really a surprise –, and the five key requirements for restoring stability and efficiency in the EU/OECD banking sector are highlighted. Most important, however, is the introduction of a new tax regime designed to encourage bankers to take a more long term time horizon in decision-making and to reduce excessive risk-taking. Banks and funds should be taxed not only on the basis of profits but also on the basis of the variability – read variance – of the rate of return on equity: the higher the variability over time the higher the tax to be paid. The quality and comprehensiveness of banks’ balance sheets must be radically improved and all off-balance sheet activities must be included in future total balance sheets. The medium term structure of employment in terms of the breakdown nontradables/tradables will have to adjust.