Now Italy (which represents about 11% of the EU’s GDP) is also finding itself in a banking crisis. Its banks are linked to all of Europe’s banks that have bought Italian paper. It is possible for the Italian government alone to bail out the banks—a move not allowed under current EU rules. But at the end of the day, Italy does not own the printing press that can help monetize the banks because that belongs to the European Central Bank (ECB).
The political reality is that the ECB is heavily influenced by the Germans. In other words, the Germans control the monetary supply, but they intend to push the responsibility of solving the banking problem to the Italians. This could lead to a crisis similar to the one experienced in Greece… but on a much larger scale. Essentially the Germans are demanding that, if Italian banks fail, a form of the Cyprus solution be implemented in Italy. The potential consequences for the European financial system are hard to calculate, but at the moment, German Chancellor Angela Merkel is reassessing her political position, which has eroded since the onset of the refugee crisis.
The international dimension of the banking system is also at a critical stage. As the exporters’ crises deepen, the ability to maintain comprehensive deposit guarantee schemes is key for countries like Azerbaijan and Russia. Two factors to watch are deposit levels and capital flight. Russia has struggled with high levels of capital flight, and further outflows could indicate that efforts to promote confidence in the system are failing.
At the same time, negotiations over the future of the planned EDIS will be a key indicator, both for the stability of Southern European banking systems and the relationship between Germany and the rest of the eurozone. From Russia to China and the European Union, public confidence in banking systems is a factor that affects not only financial stability, but the survival of regimes and political institutions.
There is no international financial institution that can possibly deal with all these potential failures… and certainly none that can deal with the social consequences. When we look at Eurasia, we see banking problems that need to be solved. The solution has three layers: first, to maintain a prudent banking system; second, to provide a reliable insurance system for deposits; third, to provide security for deposits through the government, which ultimately has the resources and an interest in political and social stability. But if prudence has already collapsed and if the insurance system is incapable of coping with the flood, only the third layer remains. However, if it is beyond the state’s will or capacity to act effectively, simply put, there will be hell to pay.
George Friedman is editor of Mauldin Economics' This Week In Geopolitics.