Europeans working on bank ‘recapitalisation’ plan

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Germany stands ready to help recapitalise its banks if necessary, German Chancellor Angela Merkel said yesterday (5 October), providing relief to financial markets amid speculation that policymakers were working on plans to boost bank capital to contain the euro zone debt crisis.

"I think it is important, if there is a general view that the banks are not sufficiently capitalised for the current market situation, that one does it," the German Chancellor told a press briefing during a visit to Brussels yesterday (5 October).

"The German government – as the finance minister has made very clear in the last two days – stands ready to implement such a capitalisation of the banks if it is needed," Merkel said.

"Germany is prepared to move on bank recapitalisation," she said adding: "We need criteria, we are under the pressure of time and we need to take a decision quickly."

"If we need to discuss this at the summit we are certainly prepared to do that," Merkel said.

Leaders from the 27 EU member states will be meeting in Brussels on 17-18 October for a regular summit meeting. Heads of states from the 17 countries that share the euro currency will break out on the second day for a separate session.

Banking plan is 'no secret': IMF

Worries have mounted in recent days that the euro zone debt crisis could spread to the banking sector, with Franco-Belgian bank Dexia facing a breakup and a public bailout due to speculation about its holdings of toxic Greek assets.

Europeans have now started to realise that something must be done to shore up the banking sector.

"There is no secret at all that European authorities and the European Commission are all working together on a plan to bring more official, public capital into the banking sector precisely to restore confidence," the European head of the International Monetary Fund, Antonio Borges, said on Wednesday (5 October).

"There is a general consensus that this is urgent, and should be done in the next few weeks," said Borges.

He estimated that Europe needs to pump as much as €200 billion into its banks. 

National or EU money?

In Brussels, Angela Merkel said bank recapitalisation plans would probably have to go hand in hand with "adjustments" on the second Greek bailout plan, suggesting private bondholders could make deeper losses in case of a bank restructuring.

It is also unclear whether the money to help bank recapitalisation should come from the euro zone's €440 billion bailout fund or from national coffers. "Whether the money comes from the national treasuries or, in the final instance, from the EFSF, is to be decided, country by country possibly," Borges said.

Using EFSF money would be controversial in Germany, which is the biggest contributor to the EU bailout fund. "I don't see the EFSF as ideal instrument for bank recapitalisations," said one top German banker. "Why should German taxpayers pay for problems of Greek banks? Every country should bring its own house in order."

France too is hesitant, but for different reasons. France's top banks – BNP Paribas, Societe Generale and Credit Agricole – have seen their stock price roughly halve since the start of the year, suggesting the recaptialisation could be a costly exercise for France if it was to shoulder the burden on its own.

Ahead of presidential elections in 2012, this could cost France its top-notch credit rating.

Rather than injecting capital, the government would prefer to resurrect a scheme used at the beginning of the banking crisis in 2008, offering funding guarantees and buying preference shares in banks, a type of loan that counts as capital.

Germany has used a combination of guarantees and equity, mostly without taking shareholdings. It has only fully nationalised one bank in the crisis although many more were badly hit.

These solutions have helped Berlin and Paris avoid becoming entangled with their banks – both expensive and politically embarrassing.

"The EFSF cannot be a magic solution because its charter does not allow countries that are contributing to it to actually use it at the same time," said one economist, who asked not to be identified.

"The likeliest outcome is that France and Germany, via the EFSF, will shoulder the burden of bolstering banks in the periphery of the euro zone and will in turn recapitalise their own banks outside the EFSF framework."

Preventing further contagion

In order to have credibility, however, any plan must go further, said Daniel Gros, who heads a Brussels think tank, the Centre for European Policy Studies.

"I don't want to see a coordinated plan with lots of national schemes. I want one European plan – one European institution that recapitalises the banks.

"The EFSF now has to give money to countries. But it should be able to capitalise banks itself. Which bank wants the Italian government, for example, as a shareholder? And which weak government wants to be a shareholder in a bank?"

Whether helping the banks with extra capital succeeds in helping to revive market confidence may ultimately depend on whether investors in Greek debt are forced to take bigger losses, as Merkel suggested.

Should this happen, insulating banks and other European countries may prove difficult, if not impossible, one EU official said. "There is very little you can do. No one knows where money would run to in a situation like that. The reason (US Treasury Secretary Timothy) Geithner came to Poland is because he does not have any wall (to stop contagion). Neither does the UK."

Dexia became the first casualty of the Greek debt crisis this week when France and Belgium announced they would step in to save the troubled bank.

Dexia was one of the first European banks to be bailed out in 2008 following the financial crisis. It holds €20.9 billion in sovereign debt issued by troubled eurozone countries, including Greece and Italy.  

European Banks face a €148 billion euro capital shortfall under a base case and a €227 billion shortfall under a stressed scenario, according to analysts at JPMorgan, who say Unicredit, Deutsche Bank, Lloyds, Societé Generale and Barclays each face a deficit of over €7 billion under its stressed scenario.

If banks are unable to raise the capital privately, government ownership of the sector could jump to 22% from 7% now, JPMorgan analyst Kian Abouhossein said in a note.

  • 17-18 Oct.: EU leaders to examine bank recapitalisaiton scheme during regular summit in Brussels.

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