International Monetary Fund Managing Director Dominique Strauss-Kahn.

European Union-wide authority to deal with failed banks is needed to strengthen the region’s post-crisis banking system, the head of the IMF, Dominique Strauss-Kahn said in a speech last Friday. He also said that "pretense of progress" but continuing  business as usual, is not sufficient.

Speaking to a European Commission conference in Brussels, Strauss-Kahn said existing schemes for dealing with failed cross-border banks have proved inadequate. As a result, national and cross-border bank failures have been difficult to handle effectively and have been costly for governments and taxpayers. 

“Europe needs a fire brigade,” said Strauss-Kahn, to extinguish banking problems when they erupt, and intervene when things get out of hand. Describing risk-taking as the essence of banking, Strauss-Kahn said the key is in designing a financial system that contains the risks while harnessing the benefits. To grow out of the global economic crisis, Europe will need financing for its businesses, and healthy financial institutions to provide the means for economic growth, said Strauss-Kahn.

Casting a wide net to prevent and manage crises: The former French finance minister said the freedom of banks to operate across borders is essential for healthy competition, but this kind of integrated banking system also needs ways to prevent and resolve banking crises when they occur.

Referring to the lessons from the global crisis, Strauss-Kahn said banks home and host countries would gain from more cooperation and better control, as well as joint responsibility and accountability.

The proposed European Resolution Authority would be equipped with the tools to deal with failed banks in a cost-effective way.

This approach would make sure that losses are borne by shareholders and holders of equity, and by uninsured creditors.  As much as possible, the system should be pre-financed by the banking industry, including through deposit insurance fees and any levies on financial institutions.

Strauss-Kahn also said the IMF is putting together proposals on ways to tax the financial sector, which will be presented to the G-20 group of advanced and emerging economies in April.

Laying responsibility for safe banking systems firmly with banks themselves, Strauss-Kahn said self-discipline was not enough. Good regulations and supervision to safeguard the public interest, and the means to detect problems early, are required.

Far reaching costs of failed banks: Bank failures not only take a toll on a country’s financial system, but also on their balance sheets, as well as create a burden on taxpayers, said Strauss-Kahn.

Reform of financial regulation and supervision, based on the recommendations by the de Larosière Group, a group of experts on financial issues set up by the European Commission, is only one half of the equation, said Strauss-Kahn, adding that Europe needs a fundamental overhaul of its financial stability architecture.

“The crisis has hit ordinary people very hard,” said Strauss-Kahn.“Modest reforms that maintain a pretense of progress but continue business as usual are not sufficient.”

IMF Paper: Crisis Management and Resolution for a European Banking System