Financial hub Luxembourg under increased scrutiny

Time Bomb? The balance sheets of the country's banks have swollen 22 time its GDP

Written by Associated Press | Brussels | Published: April 8, 2013 1:15 am

As the European Union’s wealthiest country,Luxembourg could have been forgiven for thinking that it would never find itself on the bloc’s financial risk list.

With just half a million people living on a tiny patch of lush land nestled between Belgium,France and Germany,Luxembourg is as tranquil as a buzzing financial centre gets.

Still,some of Europe’s regulators and politicians have started wondering aloud whether its banks might be holding the 17-nation euro zone’s next ticking bomb.

Following the chaotic bailout for Cyprus last week,European officials have been drawing worrying comparisons between the two countries’ oversized financial industries. Mario Draghi,president of the European Central Bank,cautioned on Thursday that “the recent experience shows that countries where the banking sector is several times bigger than the economy are countries that,on average,have more vulnerabilities”.

“Financial shocks hit these countries stronger,simply because of the size of their banking sector.” The increased scrutiny has taken Luxembourg’s government by surprise and put it on the defensive. It has rejected calls to shrink its country’s main source of wealth to a more manageable size,claiming that its banking industry is much more secure than Cyprus’s and any crackdown would not only harm its own economy but that of the wider euro zone.

The balance sheets of the banks in Luxembourg have swollen to about 22 times the country’s annual economic output of 44 billion euros — making it Europe’s richest country per capita. The country is also the world’s second-largest centre for investment funds,with about 3,800 funds holding assets worth 2.5 trillion euros — about 55 times the country’s gross domestic product. It has 141 banks based there,with five of them domestic institutions and the remainder being mainly divisions of foreign banks.

“There are no parallels between Cyprus and Luxembourg,and we don’t allow any parallels to be forced on us,” Prime Minister Jean-Claude Juncker said last week. “Cyprus is a special case; other financial hubs in Europe don’t have these problems.”

Luxembourg also has relatively little debt,so it could afford to borrow to bail out the odd bank. But if it faced a widespread problem,it might not be able to cope.

If things in Luxembourg’s financial sector were to go wrong,the country might not get help from its euro zone partners so easily. For one thing,it won’t be able to say it wasn’t warned.

Jeroen Dijsselbloem,the plain-spoken chairman of the bloc’s 17 finance ministers,warned other countries with outsized banking sectors to “deal with it before you get in trouble”.

The success of Luxembourg’s financial sector was initially fuelled by lax regulation,secrecy and low taxes. This made it a popular tax haven and money-laundering spot. The country later changed many of its laws following pressure by its European partners. But critics say the financial industry still lacks the necessary transparency.

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