Bloomberg News

IMF Sees 300 Billion-Euro Credit Risk to Europe Banks

September 21, 2011

(Updates with capital estimates, quote from analyst from sixth paragraph. See {GMEET <GO>} for more on the IMF meetings.)

Sept. 21 (Bloomberg) -- The European debt crisis has generated as much as 300 billion euros ($410 billion) in credit risk for European banks, the International Monetary Fund said, calling for capital injections to reassure investors and support lending.

Political squabbling in Europe over ways to fight contagion and delays in implementing agreed measures are raising concern about the risk of government defaults, the IMF said. Banks, in turn face “funding challenges” because investors are concerned financial institutions will potentially show losses on government bonds holdings, and reliance by some on the European Central Bank for liquidity, it said.

“A number of banks must raise capital to help ensure the confidence of their creditors and depositors,” the IMF wrote in its Global Financial Stability Report released today. “Without additional capital buffers, problems in accessing funding are likely to create deleveraging pressures at banks, which will force them to cut credit to the real economy.”

The Washington-based IMF yesterday cut its global growth forecast and predicted “severe” repercussions if policy makers fail to stem the debt turmoil that’s threatening to engulf Italy and Spain. Bank recapitalization, through public injections if necessary, should come in addition to “credible” strategies by governments to reduce their public debt, the IMF said today.

Stress Test

The fund said its assessment of the potential credit risks of European banks isn’t a calculation of their capital needs, which would require a “fully fledged stress test.” It said its analysis was based on published data from the European Banking Authority’s stress test and Bank for International Settlements figures.

Banks in the region may face a 400 billion-euro capital shortfall, factoring in another recession and a 21 percent impairment on Greek, Irish, Italian, Portuguese and Spanish debt, Jon Peace, an analyst for Nomura International Plc in London, wrote in a note to investors on Sept. 7.

Analysts at Credit Suisse Group AG in a Sept. 15 research note estimated the capital deficit to be 165 billion euros at the end of 2012, “given higher regulatory capital demands and funding markets requiring larger capital cushions.”

Unlimited Lending

The ECB and peers in the U.K., Switzerland, Japan and the U.S. last week said they’ll provide unlimited three-month money to lenders in three tenders starting October. That was after funding dried up for European banks in general, and French lenders in particular, amid concern Greece is headed for a default.

Credit Agricole SA and Societe Generale SA had their long- term credit ratings cut one level this week by Moody’s Investors Service, which cited their reliance on short-term funding and Greek exposure.

“The usual way to deal with a banking crisis is through a state-led bailout or recap operation, but it was the concern about the sovereigns’ ability to deal with their obligations that started the whole process in the first place,” said markets, said Stephen Jen, managing partner at SLJ Macro Partners LLP in London.

“Investors will have a hard time handicapping the risks and will likely insist on a risk premium higher than they would otherwise if the vicious circle were not there.”

Fiscal Plans

The IMF also called on the U.S. and Japan to craft fiscal plans for the medium term, “particularly given the many adverse global economic and financial repercussions that would follow from failure to adequately deal with U.S. fiscal problems.”

The IMF is not judging the European stress tests published earlier this year, said Jose Vinals, the head of the agency and capital markets department.

“Since then, things have changed,” he told reporters in Washington today. “There is a significant spillover of sovereign risk into banks and that this is something that is creating market strains.”

“This is something which supervisors will need to look at very carefully and then decide what is the size of capital buffers that the banks must get in order to get funding in appropriate conditions,” Vinals said.

The S&P 500 slipped 0.6 percent to 1,195.05 at 2 p.m. in New York, extending losses as Moody’s Investors Service cut its debt rating on Bank of America Corp. The yield on the 10-year Treasury note fell to 1.92 percent from 1.94 percent late yesterday.

Emerging-Market Banks

Emerging-market banks are not sheltered from the consequences of weaker global growth, the IMF said. It estimated that their capital adequacy could be dented by 6 percentage points under a scenario that combines several shocks.

Calls by IMF Managing Director Christine Lagarde to recapitalize European banks where shunned by officials from Germany to Spain, with ECB President Jean-Claude Trichet describing the fund’s methodology on capital as different from his own institution’s.

The IMF analysis measured the size of spillover on banks from credit-related strains in the bond markets of Greece, Ireland, Portugal, Belgium, Italy and Spain and used spreads on credit default swaps.

The IMF said banks’ “spillover” from sovereign debt alone amounts to about 200 billion euros. Adding banks’ holdings of bank assets whose value has also fallen in the crisis countries brings the total as high as 300 billion euros.

--With assistance from Fabio Benedetti-Valentini, Rebecca Christie in Brussels and Sonia Sirletti in Milan. Editors: Carlos Torres, Vince Golle

To contact the reporter responsible for this story: Sandrine Rastello in Washington at srastello@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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