Conventional wisdom may now be only half right when it comes to solving Europe’s mess. Fixing the sovereign debt problem is still necessary, but it may no longer be sufficient. Europe must also move quickly to stabilise the banks at its core in ways that go far beyond what the European Central Bank announced on Wednesday. As senior BNP Paribas executives prepare to tour the Middle East in an attempt to raise fresh funds and shore up confidence, other banks must also show greater urgency and seriousness in dealing with capital and asset quality shortfalls.

Much of the discussion on the crisis is based on the assumption that sovereign debt is both the problem and the solution. Initially, this was correct. The combination of too much debt and too little growth pushed the most vulnerable countries (Greece, Ireland and Portugal) into a classic debt trap. Timid policy responses then fuelled contagion waves that undermined other sectors.

The problem today has become much more complicated. In addition to being on the receiving end, some of these sectors have become standalone sources of regional dislocations.

Italy is, of course, the most visible example. Interest rates on what is the third-largest government debt market in the world remain stubbornly high in spite of persistent market intervention by the ECB. Wednesday’s rating cuts of some of Italy’s leading banks, following Standard & Poor’s downgrade of the country’s sovereign debt on Monday, complicates matters.

Yet, as notable as this is, it is not the most immediately threatening issue for a global economy that, in the words of Christine Lagarde, International Monetary Fund managing director, has entered “a dangerous phase”. The rapidly burning fuse is in the European banking system, particularly in France, and Europe is getting very close to yet another tipping point.

The facts are striking and worrisome. Private institutions around the world, and even some public ones, have sharply reduced short-term lending to French banks. Credit markets now put their risk of default at levels indicative of a doulbe B rating, which is fundamentally inconsistent with sound banking operations. Bank equity now trades at a 50 per cent discount to tangible book value on average. To make things worse, the ratio of market capital to total assets has fallen to 1–1.5 per cent (compared with 6-8 per cent for healthier banks).

These are all signs of an institutional run on French banks. If it persists, the banks would have no choice but to delever their balance sheets in a very drastic and disorderly fashion. Retail depositors would get edgy and be tempted to follow trading and institutional clients through the exit doors. Europe would thus be thrown into a full-blown banking crisis that aggravates the sovereign debt trap, renders certain another economic recession and significantly worsens the outlook for the global economy.

So far neither the authorities nor the banks have done, or are doing, enough to stop – let alone reverse – this trend. While the ECB has stepped in to offset the liquidity crunch, including by relaxing collateral requirements to make it easier for banks to access the central bank’s repo window, capital cushions and asset quality remain unaddressed. As a result, Europe is on the verge of losing control of orderly solutions to its debt crisis.

To counter this, fiscal authorities and banks must work with the ECB on three immediate, simultaneous and drastic measures. They must inject capital through public-private partnerships, including through Tarp (US troubled asset relief programme)-like mechanisms, present a realistic assessment of the asset side of the balance sheet and enhance depositor protection. Greater burden sharing with the private sector may also prove necessary.

Through the bitter experience of the last two years, Europe now understands that a sovereign debt problem is difficult to solve. It must now realise that the challenges and costs to society multiply astronomically when this is accompanied with a banking crisis; and it must act accordingly.

The writer is the chief executive and co-chief investment officer of Pimco

Both Mr Mohamed El-Erian’s article and Mr Magnus’s response include inaccuracies, as far as BNP Paribas is concerned.

Senior executives are not preparing a tour to the Middle East in an attempt to raise fresh funds, as confirmed this morning by our CEO Baudouin Prot. He reminded the market that BNP Paribas, which currently has a common equity Tier one ratio of 9.6 per cent, intends to be at nine per cent under the full Basel 3 rules by 1st of January 2013, six years ahead of the official schedule. The only people to tour the Gulf at present are members of our investor relations department, who are not members of the Executive Commitee of the bank, and who go to this region as a part of their usual global roadshow programme.

The article mentions that private institutions around the world have sharply reduced short-term lending to french banks. Regarding BNP Paribas, most of our short term lending and deposits are in euro, and we therefore didn’t observe such a move. Concerning our funding in dollars, we had anticipated, from the beginning of 2011, that deposits from American money market funds were going to be reduced and took appropriate measures to ensure the appropriate level of short term liquidity, using a range of means provided by our global presence. Our short term liquidity in dollars is thus fully ensured.

We didn’t urge the french regulators to do any kind of stress test.

Regarding Greece, BNP Paribas has a very clear situation : €3.5bn of sovereign debt, but almost no exposure to the private sector. This figure needs to be compared to our first half 2011 pretax profit of €7.4bn: this shows that whatever happens to Greece, the outcome is easily manageable.