Earlier this week, European Union regulators announced a bailout of Banco Espirito Santo (BES) – a Portuguese bank that was on the edge of insolvency. The bailout wasn’t significant in that it posed a threat to the European banking system or the global economy, but its handling did signal a return to post-crisis taxpayer-protective policy.

The new structure of BES has assets separated into two entities; a “good” bank and “bad” bank. The good bank will be owned by a government rescue fund, while the bad assets will be held by the equity and junior bondholders.

This treatment of the bank’s investors signals an end to the European banking crisis and a new era of fiscal responsibility for European banks. During the recession, EU regulators protected banks – and investors in those banks – at all costs. Those investors were often other European banks, who in turn held a great deal of government sovereign debt. With banks and governments intertwined in this way, it was difficult to charge the cost of bailouts to anyone except taxpayers.

Now, European banks have been put on notice that they must get their act together, and investors must choose wisely, or be on the hook for the performance of these institutions.

The timing of this treatment is not incidental. This fall, European regulators are set to conduct a series of stress tests on European banks. The near-failure of BES has made investors nervous that other banks may have monsters lurking in their financial closets that will cost them dearly.

That’s part of the reason we’re still seeing a weakness in lending by European banks, which are wary about risking their capital ratios on poor loans. And that leaves the European Central Bank with the burden of continuing to juice the European economy with low interest rates. However, while that can entice borrowers to ask for money, it can’t compel banks to lend it.

My View: The BES decision is a healthy turn for the European economy, but as we have been saying for years now, Europe still has a long path back to prosperity.

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