The problem with euro-zone banks’ model

Banks in the euro zone are faced with the following problem: Their assets (essentially loans) are increasingly risky, given the repetition of crises, and their liabilities (essentially deposits) have to be risk-free. This is only possible if banks hold an increasingly high level of capital to absorb potential losses on their assets. Banking risk is high, and therefore so is the risk premium on bank shares and therefore so is banks’ cost of capital (equity capital). If banks hold a very high level of costly capital, the cost of banks’ financial intermediation is high, which is a brake on the economy . So what solutions are there? Banks could transfer risk to investors (insurers, etc.) via large-scale securitisation . B ut do investors want to take this risk? Banks could be nationalised and capitalised by the government, given its low required return on equity and willing ness to not be compensated for its risk-taking.