If you’re in the banking industry, you should keep an eye on Slovenia.
On the face of it, that’s an odd thought—Slovenia is a tiny Central European nation-state with a significantly smaller population than Brooklyn. However, despite the diminutive size and relative obscurity, it perfectly encapsulates the complex issues that dominate the current global economic environment.
A new report from the Organisation for Economic Co-operation and Development (OECD) that builds on an economic survey of the nation’s banking landscape is causing consternation in banking circles worldwide, and it should. The report states that Slovenia is on the brink of a serious banking crisis that could have catastrophic consequences. Here’s a taste: The nation’s public debt is almost half its GDP, just about double what it was barely four years ago. Unless there are drastic changes, the OECD warns, the debt will actually match the GDP by 2025.
What’s particularly scary about the situation is that in this inter-connected economy, if one player gets a cold, then everyone else sneezes. Slovenia is by no means alone in facing a fiscal crunch—for example, Cyprus is dealing with a very messy bailout, with financial contortions that include selling off $525 million worth of gold reserves. In other words, this is possibly a domino effect, and no one is quite sure where the last one stands.
There are historical factors that deserve consideration too. Unlike other former Communist bloc states that joined the European Union, Slovenia stayed mostly public, meaning that its banking sector didn’t go into private ownership. Today, 20/20 hindsight suggests that everything from managerial incompetence to outright political fraud may have contributed to the current blight.
Whatever the reasons, we may be seeing the perfect storm of economic problems: the woes of a long-discredited communist structure combined with the perils of being on the losing end of a competitive, free-market environment.
So if that’s the diagnosis, what’s the cure?
Slovenian Prime Minister Alenka Bratusek maintains that while the situation is critical, and fixing the banking industry is her government’s top priority, the country does not need a bailout. Her view is backed by European Commission president José Manuel Barroso, who dismisses any similarity to Cyprus. So maybe there isn’t a line of dominoes falling.
Still, there’s no question that just averting another bailout in a small nation isn’t exactly a high standard of success. What comes next?
Freshly appointed U.S. Treasury Secretary Jack Lew is currently trekking through Europe discussing these challenges with, among others, Barroso and European Council President Herman Van Rompuy. “Our economy’s strength remains sensitive to events beyond our shores,” he said in what might be described as an understatement.
Lew is aggressively pushing for the creation of a euro zone banking union. This body, which has been in the works for a while, will entail handing over supervision to the European Central Bank, as well as the passage of new bank resolution laws. Reports indicate that the single bank supervision will be implemented sometime in 2014, with a single bank resolution mechanism sometime shortly thereafter. The primary goal would be to allow the 17-nation bloc to handle emerging crises, such as Cyprus, with greater urgency.
In a sense, it’s an ironic twist. The justification behind the creation of the European Union was to draw from strength in numbers and greater flexibility. EU advocates consistently maintained larger members would pull up smaller states, not be dragged down by them. It was also never supposed to lead to constant consolidation.
Besides, the creation of a banking union to deal with emerging crises assumes that crises will continue to emerge—a sobering thought by any measure. But for now, let’s keep our eye on Slovenia and hope it gets through the storm, and that all other dominoes continue to stand upright.