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According to Reuters, EU finance ministers have prepared a statement calling for European banks to raise their capital.The move would signal acknowledgment of the ineffectiveness of bank stress tests conducted by the European Central Bank in July. This couples mounting speculation that banks may indeed get hammered by a sovereign default — a contingency not raised by the bank tests.
The statement suggests that European banks may indeed need more capital and be facing a credit crunch.
The document states:
Despite the increased resilience of European banks and the limited remaining refinancing needs for the rest of 2011, in view of a compelling market pressure for an increase in banking capital benchmarks and with the aim of dispelling any doubts on the intrinsic stability of most banks, a further reinforcement of bank resources is advisable at this juncture…
This is important for banks that have failed the stress test, but also for those that have passed the test but with capital level close to the relevant threshold, and particularly with sizeable exposures to sovereigns under stress.
It is once again unclear where capital to bolster such banks will come from. Banks that failed the tests were ordered to increase their ratio of tier 1 assets to liabilities to 5% by the end of the year, or accept money from their domestic sovereign government. However, those tests never accounted for the fact that a heavily indebted sovereign government might not be able to finance such recapitalization.
This statement falls short of suggesting that public money should be used to recapitalize European banks.
On one hand, the admission of banks’ vulnerability could shake markets by indicating that the banking situation is more grim than previously thought.
On the other hand, this resolution could mark a turning point in eurozone policy. Instead of buying bonds, the ECB and European Financial Stability Facility could be focusing on strengthening banks to bolster investor confidence.
Investors could be hopeful that such a policy would precede the implementation of a TARP-like program to recapitalize banks with public funds.
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