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Moody's Warns European Banks Need More Cash

European Central Bank
European Central Bank

Banks in Spain, Italy, Ireland and Britain need to set aside much more money to cover potentially bad loans, credit ratings agency Moody's said on Thursday, meaning European taxpayers may again be tapped for cash.

European banks have already raised hundreds of billions of euros to cover possible losses from loans that soured in property and financial market crises. Much of the funding has come from governments.

"We believe that many banks, in particular in Spain, Italy, Ireland, and the UK, require material amounts of additional provisions to fully clean up their balance sheets," Moody's said in its global banking outlook for 2013.

"Some banks have in recent years delayed full recognition of embedded loan losses, partly by restructuring loans," the report added. "This strategy of buying time (often tolerated by regulators) limits a bank's capacity for new lending and poses risks for creditors of European banks."

Moody's did not say how much extra money banks would need.

Rival agency Fitch also warned on Thursday that British banks could be underestimating the riskiness of their property loans and may need more capital to correct this.

(Read More: Recession-Hit Euro Zone Has Turned a Corner: PMIs)

Moody's believes 2013 will be a volatile year for Europe's banks, but expects their credit ratings to remain relatively stable after a raft of downgrades in 2012.

The agency's outlook for U.S. banks is negative due to a challenging home market, while its outlooks for Asia/Pacific, Emerging Europe and Latin America are stable.

Measuring Risk

Fitch's view on British banks' assessment of risk chimes with comments from the Bank of England (BoE) in November.

The BoE said Britain's four biggest banks - HSBC, Barclays, Royal Bank of Scotland and Lloyds - could be over-stating their capital levels by between 5 billion and 35 billion pounds ($55 billion) because of the way they measure risk.

Britain's Financial Services Authority is reviewing how banks weight the riskiness of their loan books and lenders will be told by March if they need to beef up their capital reserves to protect against loans going sour. The results of the review are not expected to be made public.

"We expect that banks will have to set aside more capital and that this requirement will probably be addressed either by way of additional capital buffers or higher risk-weightings for certain classes of loans," Claudia Nelson, senior director of financial institutions at Fitch, told Reuters.

"The measures are likely to be introduced gradually."

A Fitch study showed how retail lenders' assessment of their loan books has grown rosier since the financial crisis despite rising unemployment and a poor economic outlook.

From the end of 2007 to the end of June 2012, the banks' risk weighted assets (RWAs) nearly halved to 35 percent from 65 percent despite their loan books, comprised mainly of mortgages, staying relatively stable.

The lower the RWA weighting the greater the chance the loan will be repaid and the less capital a bank needs to hold on its books.

A study of banks with a higher exposure to residential mortgages revealed an even sharper fall in their perceived risk, despite a weaker property market, Fitch said.

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