Can eurozone banks be strengthened?


There was progress towards a eurozone rescue deal during the IMF's annual meeting in Washington, according to those present. But they caution that a workable proposal cannot yet be banked.

There were two positive developments.

  • First a de facto deadline for agreement on a rescue package was set. This phased deadline will be the European Union council meeting in Brussels at the end of October and the G20 government heads meeting in Cannes at the beginning of November.
  • Second, the outlines of the rescue deal, with three main elements, were sketched.

Here are the elements.

Greek haircut

There would be a haircut or writedown of Greek sovereign debt of 50%. This appeared to have been leaked at the end of the week by the Greek Finance Minister, Evangelos Venizelos, as per his reported remarks to Socialist MPs that a 50% "haircut" was the best of three available options.

The Ta Nea newspaper quoted Mr Venizelos as saying: "It is very dangerous for us to ask for it; this requires agreed and co-ordinated effort by many."

For what it's worth, the Greek authorities subsequently denied that such a restructuring of Greek debt is under active consideration, though that's not what European Union officials tell me privately.

Bailout boost

The next element would be that the EU's bailout fund, the European Financial Stability Facility, could acquire more firepower than its revised financing limit of €440bn.

This would be done not by enlarging the facility - which is seen as politically and practically impossible, because that would require fresh approval by reluctant parliaments in eurozone member states.

Instead the EFSF would do something a bit different from its original conception. The EFSF would take on the main risk of lending to governments struggling to borrow from normal commercial sources - governments like Italy - and it would do this by providing what's known as first-loss capital or equity.

In this way, the EFSF would make it less dangerous for the European Central Bank to lend alongside it.

Lending power

So the EFSF's 440bn euro could be "leveraged" or enhanced by say 1.5 trillion euro of loans from the ECB. There would therefore be around 2 trillion euro of standby credit available for eurozone governments shunned by the market.

Many analysts believe 2 trillion euro of lending power is the bare minimum needed by the EFSF for it to have credibility, given the massive refinancing needs of Italy over the coming three years. So this reconfiguration of the EFSF looks clever.

That said the wheeze could be too clever by half: it would involve much more risk being heaped on eurozone taxpayers, so MPs in eurozone member states may go ballistic if deprived of a vote on the reform.

Recapitalising banks

Finally, eurozone finance ministers and central bankers in Washington have broadly accepted the need for the recapitalisation and strengthening of the eurozone's banks to be accelerated and enlarged - or so I am told.

Which is positive mood music.

Even so, there would be massive technical and political obstacles in the way of actually injecting sufficient capital into Europe's banks so that they can absorb potential losses from the putative 50% writedown of Greek sovereign debt, and possible losses on loans to other financially over-stretched eurozone countries.

Banking conundrum

It is the gulf between how investors and creditors see these banks, on the one hand, and how they are seen by eurozone ministers and regulators, that makes the banks so hard to fix.

Eurozone - other recent views

The New York Times' Paul Krugman is "both terrified and bored" by the eurozone crisis - terrified because he remembers the last depression led to World War II.

In an eight-step plan to avoid a depression, professor of economics at New York University Nouriel Roubini, advises in Project Syndicate that Greece and others leave the eurozone.

Former chief economist of the IMF Simon Johnson explains, in the Baseline Scenario blog, that the IMF doesn't have the kind of funds to bail eurozone countries out of the debt crisis.

In the Street Light blog, economist Kash Mansori puts forward an argument for why joining the euro caused the debt crisis of eurozone countries.

Here's the thing. Big lenders to banks, especially the US money market funds, are reluctant to provide vital finance to eurozone banks, especially French and Italian ones, for fear that they will be brought to their knees by their loans to eurozone states with excessive debts.

This market view of the weakness of these banks has to an extent been corroborated by a recent IMF analysis (in its latest Global Financial Stability Report), which argued that the potential losses for eurozone banks from the sovereign debt crisis could be as high as 300bn euro - and that losses on this scale could see 22% of European banks suffering erosion of their capital resources of at least 50%.

The IMF did concede that these were fairly imprecise estimates - and it did not have access to data on how many European banks had already recognised some or all of these losses. But the number floating around Washington for the size of future losses that the banks might incur from the eurozone crisis was 200bn euro.

Regulators v governments v banks

So here's another thing. The recent health checks by European regulators of European banks - the so-called stress tests - found that most of them were tickety boo. According to the coordinating body for the tests, the European Banking Authority, just eight banks (mostly small ones you've never heard of) needed to raise a paltry 2.5bn euro in aggregate.

So how on earth do eurozone governments force the banks perceived by investors to be vulnerable - banks like Unicredit of Italy, or BNP Paribas, Soc Gen and Credit Agricole of France - to raise expensive capital, when their respective regulators have already ruled that they don't need to raise capital?

An effective cordon sanitaire around the banking system, that would remove the risk of a full-scale banking crisis, almost certainly requires tens of billions of euros of capital to be injected into big Italian and French banks, for example, because they have been finding it harder and more expensive to borrow in recent weeks, and their shares have plummeted.

But goodness only knows how this can be made to happen.

Precious capital

There could be a political decision to recalibrate the stress tests, so that instead of stipulating that no bank's capital should fall below 5% of assets under stressed conditions, the new minimum capital requirement would be 7% or 8% of assets.

That's a notion that was knocking around Washington, I am told. But I am not sure it would work, even if European governments agreed to do it.

For example, lifting the capital bar would force Soc Gen to raise a fair chunk of new capital from commercial investors or the French state, but BNP Paribas would need to find only a tiny amount of new capital and Credit Agricole would not have to raise a bean.

So two giant French banks would still be seen by some investors and creditors as fragile.

Paradoxically, Royal Bank of Scotland and Barclays - which are seen as less vulnerable by investors than the French banks - would have to raise a good deal of new capital. Which, in the case of Royal Bank of Scotland, would pose an additional strain on the UK's public-sector balance sheet at an awkward time (to put it mildly).

To repeat, the mechanics of strengthening European banks look fraught with difficulties. But unless the banks are fixed, there will remain too big a risk that a financial crisis could turn the current global economic slowdown into something more akin to depression than recession.

So presumably a way to mend them will be found.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 21.

    Yes - European banks can be strengthened but who is going to pay for it.
    Goondog Trillionaire strengthened UK banks at the start of the financial crisis using UK taxpayer - mainly English taxpayer's money to do this & was remeoved from office in the backlash.
    Merkel & Sarkozy are reluctant to make the same mistake as that - & instead are playing a very dangerous high risk debt pay strategy game

  • rate this

    Comment number 20.

    re #10
    We have inflation at that level and its hurting already. Do you want really massive unemployment?

    To solve the debt crisis you'd have to borrow hugely {who's going to lend?}, acquire appreciating assets {where?} & pay back during the time of inflation. Current UK spending is not really creating future assets, its getting dribbled away or going up in smoke in Afghanistan & Libya.

  • rate this

    Comment number 19.

    To anyone who understands and predicted this crisis, repairing the banks is obviously delaying the inevitable.

    The basic problem is private debt. This can only be achieved by writing off the debt, devaluing assets, leaving banks to crash, and nationalising/regulating the rest into becoming simple utilities. This is what must happen, eventually.

  • rate this

    Comment number 18.

    God bless the youth for they shall inherit the Great Debt

  • rate this

    Comment number 17.

    The banks are well on the way to persuading the politicians to bail the banks out again! -- more debts for us.

    At some stage we will have to stop this charade and introduce a new system.

  • rate this

    Comment number 16.

    Re 10
    You are correct. But Germany would not aprove, solution, ask Germany to leave the Euro and allow the markets to do the rest.
    The cost of Holidays to the MED woud drop by 30%, but the cost of the BMW would increase by 50%.

  • rate this

    Comment number 15.

    So - don't expect a chance to vote on it but expect to hand over your taxes indefinitely to the government to give to the bankers

    a) Shut your appalling prole gobs and take what is coming to you
    b) Plutocrats are intensely able and clever people which is why we get paid all your money
    c) Even though in reality we're demonstrably inept and corrupt a) overrules everything and anything else

  • rate this

    Comment number 14.

    Interesting how Christine Lagarde is an expert on this after just a few weeks in the job. But like Geithner all she does is warn but not suggest any actual solutions that can be implemented.
    I guess if you keep on warning, sooner or later you might be right. Interesting too that the US wants Europe to have a central bank like the Fed whereas most Americans see that as a proven failure.

  • rate this

    Comment number 13.

    If I owe the bank £10 it's my problem. If I owe the bank £10million it's the bank's problem. If banks owe other banks billions it's the government's problem. If the government owes trillions - it's my problem again!

  • rate this

    Comment number 12.

    Did I miss the bit where they suggested that the Greeks leave the euro?

  • rate this

    Comment number 11.

    Recapitalise bankrupt banks? No thanks!
    If banks are bankrupt there is no point in giving them still more billions. They should be nationalised and the boards sacked for incompetence. That should have happened when they were first bailed out years ago, then they wouldn't be back asking for more now. Rewarding failure is never the right solution.

  • rate this

    Comment number 10.

    wouldn't a dose of good old-fashioned inflation (6-8% a year for a few years) be a lot less painful to all of us. . . . .

  • rate this

    Comment number 9.

    We in Ireland will watch with interest at the 50% haircut for Greek debt. As good little Europeans we have told the truth and followed our ECB masters every whim. This includes paying 100% of un-guaranteed, unsecured bondholders.

    You have to hand to the Greeks they have fudged the numbers,
    broken all the rule and refused to do what they were told.

    Smart people the Greeks.

  • rate this

    Comment number 8.

    Dear Robert,

    Rather than prop up insolvent banks the following is needed:

    1. Address shadow banking which Vickers ignored.
    2. Introduce a third sector bank with the capacity to create credit/money
    3. Do what all insolvent companies do - Sack the bank staff and reemploy them on new contracts

    Otherwise we'll end up with Zombie banks

  • rate this

    Comment number 7.

    If I borrow money that I can't pay back, the bank gets my house.
    So what has Greece secured its loans against?

  • rate this

    Comment number 6.

    they should let the banks with too much debt and shadow banks to fold then inject money from a central europe bank, it will do so much more than just pay off more debt

  • rate this

    Comment number 5.

    Sloppy economics is one thing... but spelling?

    I'm so glad I live in a democracy where these tedious decisions can be taken without any input from myself.

  • rate this

    Comment number 4.

    The world has borrowed $100 trillion dollars and spent it.

    The money has circulated around the worlds financial system and has nearly all been used up in interest payments and now resides in the bank accounts of the worlds plutocrats.

    $25 trillion of it is sat in the Bank of New York Mellon.

    The world has almost no money left. It is utterly impossible to repay the $100 trillion.

  • rate this

    Comment number 3.

    I'm so glad I live in a democracy where these tedious decisions can be taken without any input form myself.

  • rate this

    Comment number 2.

    Economics a science?

    "So presumably a way to mend them will be found."

    ..and with one bound, he was free!


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