Banks must find €108bn in new capital

Europe’s big banks will be forced to find €108bn of fresh capital over the next six to nine months under a deal to strengthen the banking system that is to be unveiled by European Union leaders.

After 10 hours of talks in Brussels on Saturday, finance ministers from all 27 EU member states endorsed an estimate of the sector’s capital shortfall that is significantly higher than initial calculations. But strong reservations from southern European countries, who will have to find the lion’s share of the money, have delayed a full announcement until Wednesday, when the necessary state guarantees are set to be agreed.

According to two people involved with the talks, the European Banking Authority told finance ministers that its final emergency stress test had identified a total of €108bn ($150bn) to be raised by Europe’s banks. This would allow lenders to meet a 9 per cent threshold for their core tier one capital ratios – a measure of financial strength that goes beyond existing requirements – after marking down to market values their sovereign bond holdings of the eurozone’s peripheral states.
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The recapitalisation plan will also include measures to co-ordinate national efforts to unblock bank funding through state guarantees for new bank bonds. But Germany successfully opposed the use of joint rescue funds to underwrite new bonds, a step analysts say is essential to improving liquidity for banks, particularly on the southern periphery.

While the size of the capital shortfall is broadly agreed, big differences remain over increasing the firepower of the European financial stability facility, the eurozone’s €440bn rescue fund, which some states would borrow from for the recapitalisation.

Diplomats said the deal proved far harder than expected because Italy, Portugal and Spain resisted signing up to raising the capital bar without more certainty about state assistance for any banks unable to raise the capital themselves. Germany, however, showed little sympathy, insisting national resources were sufficient in most cases. “It was a dialogue of the deaf,” said one diplomat.

Banks will be told to use their own resources or raise new funds from private investors, government or, as a last resort, turning to the EFSF rescue fund.

As well as banks in bail-out countries – which account for almost half the shortfall – institutions in Germany, France, Italy and Spain will be required to find new capital. No UK banks fall under the threshold.

The deal is a victory for those countries that resisted calls for the tests to be watered down, either through reducing capital demands or changing the method for writing down sovereign debt.

Although the basic assumptions in the test are largely unchanged, fresh data from national supervisors around Europe pushed up the estimate of the shortfall from the €80bn figure calculated by the EBA last week. Even so, the final figure falls well short of some market estimates of the necessary amount. A recent International Monetary Fund report identified a €200bn hole in banks’ balance sheets stemming from sovereign debt writedowns, while other analysts have put the deficit as high as €275bn.