European Central Bank
The eurozone has to make key financial reforms to prosper in the future says Benoit Cœuré (Reuteurs)

The eurozone must reform its financial sector to flourish in the future said a senior member of the European Central Bank.

Benoit Cœuré, who is a member of the ECB's executive board, gave a speech in Beijing where he said the eurozone is at the crossroads.

"We have, so to speak, come to a crossroads in Europe," he said.

Policymakers in the eurozone have two stark choices that would determine the fate of the eurozone, according to Cœuré.

"The authorities can either choose between swiftly auditing and repairing the banking sector, which will help restoring credit flows, or they can allow forbearance, which will harm the long term prospects of our economy."

Two Lessons

These two opposing choices for Europe were rooted in lessons from two economic crises that had affected Asia and had vastly different outcomes said Cœuré.

"In one direction lies the Japanese experience, and in the other direction that of emerging East Asia."

Cœuré compared Europe's sovereign debt crisis to East Asia's financial crisis from 1997.

He claimed that eurozone policymakers should see it as an example of what could be done to help the eurozone while the experience of Japan offered a cautionary tale.

Policymakers in the East Asia's financial crisis had moved rapidly to reform their broken financial sectors while their Japanese counterparts did far too little and paid the price, he added.

"Given the financial nature of the Asian crisis, this was a key element in resolving it. Non-viable financial institutions were closed, viable institutions recapitalised and strengthened, value-impaired assets dealt with and the corporate sector restructured, including through foreign investment.

"These measures were implemented decisively. They were associated with a painful adjustment process in the crisis countries but, at the same time, they made a swift recovery possible."

He hinted that Japan's fate of a lost decade could be Europe's if policymakers did not make the financial sector work.

"Following the bursting of Japan's asset bubble, there was by and large no rapid write-down of non-performing assets. Due to the low profitability of banks, it was believed that an immediate write-off of bad loans would prevent compliance with capital requirements.

"The recognition of losses was postponed and, as a consequence, capital continued to be allocated to investments with limited positive impact on Japan's long-term growth potential, which some have called 'zombie lending' Ultimately, this resulted in Japan's 'lost decade', namely an extended period of anaemic growth."