Frankfurt: European bankers and politicians leapt to defend the region’s banks on Thursday, rejecting an International Monetary Fund (IMF) estimate that they need €200 billion ($290 billion) in new capital to reflect sovereign debt losses.
IMF chief Christine Lagarde’s call on Saturday for mandatory capitalisation of European banks to prevent a world recession has reignited a debate over whether they have raised sufficient capital to withstand a severe downturn.
The clash highlights diverging views about the underlying safety of the European banking system. The IMF and the International Accounting Standards Board (IASB) have both voiced concerns, while European regulators, politicians and banking associations argue that banks have a sufficient capital cushion to cope with market turbulence and worries over sovereign debt after several rounds of capital raising across the continent.
A European source told Reuters on Wednesday that the IMF had estimated European banks could face a capital shortfall of €200 billion, a figure rejected by European bankers and policymakers.
“We do not understand how the IMF has come to this conclusion. Earnings statements do not back the conclusion of such a situation among German banks,” said the German VOEB association, which represents troubled lenders such as WestLB, and HSH Nordbank.
France took a similar line on its banks, whose shares came under intense pressure during August amid concerns over access to funding, with French budget minister Valerie Pecresse saying they were not a cause for concern.
“French banks are now better capitalised than a year ago; they passed stress tests which were extremely tough less than a month ago. I don’t think there is any cause for worry over French banks,” she said at an event on Thursday.
European bank shares traded slightly lower by 1:49pm, with the STOXX 600 European banking index down 0.6%. Meanwhile, key euro-priced bank-to-bank lending rates edged higher, driven by concerns about the outlook for the economy and euro zone banks.
Michael Kemmer, head of the German banking association BdB, insisted that lenders in Europe’s largest economy were well capitalised, adding that the IMF’s view of a capital shortfall in Europe did not reflect the current situation.
“I cannot see how new risks have emerged,” Kemmer said in an interview with German daily Die Welt. “Even before the European stress tests, banks improved their capital position.”
The BdB represents lenders such as Deutsche Bank and Commerzbank , while Germany’s public sector bank body also said it saw no need for extra capital.
Although the European Commission on Monday said there was no need to recapitalise the banks over and above what had been agreed after a recent annual stress test, the health check of European banks did not factor in a significant drop in the value of sovereign debt.
JP Morgan estimated in mid-July that based on the stress test data, European banks showed a capital deficit of 80 billion euros, with UK banks needing €25 billion, French banks €20 billion and German lenders €14 billion.
The fight over whether European banks have sufficient capital highlights a flaw in the accounting treatment of sovereign debt, experts say.
“One enormous weakness is that European banks are encouraged to load up on sovereign debt without pricing in the appropriate risk penalty,” said Roger Myerson, winner of the Nobel memorial prize in economics in 2007. “It creates the wrong incentives for governments and banks.”
Myerson, who was recognised for his contributions to mechanism design theory, said that under Basel accounting rules, sovereign debt is still given a risk weighting of zero.
This encourages banks to buy risky debt without having to build an appropriate capital cushion, and provides an incentive for governments not to address their deficit levels since they are still able to issue debt.
“This looks like the entire problem of the euro zone,” Myerson told Reuters.
Europe’s top banking regulator on Tuesday insisted European lenders did not need a huge injection of capital to cope with the challenges of the sovereign debt crisis.
But accounting body the IASB said European financial institutions should have been more aggressive in booking losses on Greek government bonds. Writedowns disclosed in results varied from 21-50%.
At the low end this corresponded to the so-called “haircut” on banks’ share of a planned second bailout of Greece now being finalised. A 50% loss represented the discount markets were expecting at the end of June.
Eight European banks failed the EU stress test in July, and the total new capital they needed to remedy the situation was €2.5 billion ($3.6 billion), less than had been expected before the tests.
European banks, including major German, French and Spanish lenders, have so far successfully raised new capital from existing shareholders or from new investors willing to buy into flotations such as that of Spain’s Bankia .