Europe’s grand plan to strengthen its banking system is set to fall well short of market expectations, identifying a capital shortfall of less than 100 billion euros that must be made up over the next six to nine months, according to the latest official estimates.
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The European Union’s estimate of the necessary recapitalization effort compares with a recent International Monetary Fund report that identified a 200 billion euros hole in banks’ balance sheets stemming from sovereign debt writedowns. It also falls far short of analyst estimates that banks might have a capital deficit of up to 275 billion euros.
People familiar with the outcome of an emergency stress test of Europe’s banks said the European Banking Authority, which ran the exercise, had suggested that about 80 billion euros should be raised. That would allow banks to meet a 9 percent threshold for their core tier one capital ratios, a measure of financial strength that goes beyond current requirements, after marking down to market values their sovereign bond holdings of the euro zone’s peripheral states.
A fierce political debate has started over almost all the main assumptions used in the analysis but people familiar with the discussions expect any changes to reduce, rather than increase, the estimated shortfall.
European leaders are due to ratify the plan at the weekend, alongside a broader sweep of initiatives to strengthen the euro zone, including a well trailed project to use the European financial stability facility as a vehicle to guarantee national governments’ sovereign debt issuance.
Apparent deadlock over a mooted state guarantee system for bank bonds, seen as crucial to thaw a frozen funding market will exacerbate fears of an impending credit crunch across Europe.
“This is going to be a damp squib all round,” said one person involved in the process.
Officials said one of the reasons for the different numbers was the EBA’s inclusion of the positive impact on banks’ capital position of applying market values to the region’s better-performing sovereigns, such as Britain and Germany, offsetting the peripheral “haircuts”.
UK 10-year gilts are currently trading at 11 percent above their par value, compared with a 60 percent discount on the equivalent Greek debt and 8 percent on Italian debt.
The methodology helps the likes of Deutsche Bank – reckoned by analysts to be the hardest hit of Europe’s banks in the recapitalisation drive – and should ensure that Britain’s banks are spared recapitalisation altogether. The news will come as a particular relief to UK government officials, who had feared that the already part-nationalised Royal Bank of Scotland might need a politically sensitive injection of more bail-out money. One previous estimate by analysts at Credit Suisse had projected a 19 billion euros capital shortfall at RBS.
Under the model used, about 40 billion euros to 50 billion euros of the capital shortfall is reckoned to be at Europe’s big banks, largely in Italy, France and Spain. The rest would be spread among smaller lenders in the eurozone periphery.
Officials caution that most of the key assumptions in the EBA model – including the number of banks involved, the capital threshold and market to market model – are still the subject of debate between member states and Brussels.
While Germany has pushed for a lower capital threshold, other countries are suggesting amendments that would further reduce the overall capital shortfall, either by exempting certain banks, changing the form of capital that will count or introducing a more lenient means of valuing sovereign debt.
Even if the existing analysis is not watered down, some critics argue it is unrealistic to test for distressed sovereign debt while not including the risk of severe economic downturn, which was included in last summer’s EBA stress tests.