Spain's banking woes and cascading withdrawals on Greek financial institutions have exposed another glaring flaw in the euro-zone model.
The 17 member countries share a currency and central bank, but they're hampered by a patchwork of national banking regulators and a loose network of deposit insurance schemes.
The worry now is that a possible Greek exit from the currency bloc will spread, infecting banks in other European countries, whose governments are already badly stretched financially.
European policy makers have quietly grappled with a move toward a more-harmonized deposit insurance regime since the financial crisis erupted in 2008.
But progress has been slow and halting. A plan to set minimum standards for national deposit schemes isn't set to take effect until 2020. Member countries had pledged to study a pan-European model – in 2014.
The worsening crisis has suddenly sparked urgent talk about shoring up the regulatory and financial architecture of Europe. Media reports said the issue of sweeping bank reform is now being discussed amongst European leaders, who huddled Monday in Brussels to discuss the crisis.
The essence of the scheme would see a safety net funded by a tax on banks throughout Europe.
"In essence it would mean stronger banks and European nations subsidizing the weaker ones," said analyst Michael Hewson of CMC Markets in London.
But he acknowledged a number of problems, including the inability of ailing banks to pay the tax and the long time it would take to get the system up and running.
Some European countries are pushing for more drastic action – tapping the €500-billion ($642-billion) European Union bailout fund to directly recapitalize commercial banks.
Experts say fundamental financial reform is still the right thing to do – if the euro zone survives.
"One central bank, one financial supervisory agency and one deposit protection scheme: That would be the ideal," argued David Walker, managing director of policy, insurance and international affairs at the Canada Deposit Insurance Corp.
"But [the Europeans]are far from it. They have one central bank, but multiple regulators, multiple deposit insurance systems and multiple government fiscal authorities."
Even then, a single deposit insurance scheme isn't a panacea. It would involve potentially enormous costs and risks as problems spill across national borders because so many commercial banks have much of their capital tied up in the sovereign bonds of neighbouring countries.
"A common deposit insurance system doesn't get away from the problem of common currency risk," Mr. Walker added. "If you had a common scheme to try to prevent the problem going on now, they would have to insure all deposits in euros, even if the country were to break away from the currency regime. It would be very risky and expensive for them."
And fundamental reform would take time – time that Greece, Spain and other euro zone countries may not have.
Banks in Spain are facing an estimated €100-billion shortfall, the result of a real estate crash. And in Greece, depositors continue to move money out of domestic banks into other European banks, fearing the country may abandon the euro and convert deposits back into drachmas.
A report issued this month by the Centre for European Policy Studies in Brussels estimates that creating a European Deposit Insurance Fund would take a decade. Authors Dirk Schoenmaker and Daniel Gros advocate creation of a €55-billion euro-zone fund, to backstop the roughly 35 cross-border banks and break the trap of banks threatening the financial health of euro countries – and vice versa.
"The euro zone is caught in a diabolical loop in which weak domestic banking systems damage sovereign fiscal positions and conversely, in which risky sovereign positions disproportionately threaten domestic banking stability," the authors conclude.