Once a private financial institution infers the amount of capital it must devote to ensure against, first, illiquidity and, finally, insolvency, the size of its balance sheet for maximum rate of return on equity, adjusted for risk, is determined. That inference depends on the institution’s judgment of how much of the tail of its risk distribution requires a capital provision.
Thus, European authorities must create time to re-found their monetary union based on credible fiscal arrangements and more flexible economies that can adjust quickly to inevitable shifts in internal European competitiveness. In our opinion, the existing European resources, including the European Financial Stability Facility and the European Central Bank facilities, can be used much more efficiently to create a multi-year window for these adjustments.