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EU’s Bank Capital Plan Has ‘Serious Problems,’ IIF Says

November 02, 2011

(Updates with Dallara comments in fifth paragraph. See EXT4 and GMEE for more on Europe’s debt crisis.)

Nov. 2 (Bloomberg) -- The European Union’s plan for recapitalizing banks has “serious problems” that will hurt economic growth and make it harder for some nations to borrow, the Institute of International Finance said.

There is a “clear need” to restore confidence in Europe’s banks, IIF Managing Director Charles Dallara said today in a letter to the Group of 20 nations on the eve of a summit in Cannes, France. Yet the extra capital requirements at the center of the EU’s strategy will come with “considerable cost” because of a flawed scope and approach, he said.

European leaders are gathering today before the Nov. 3-4 summit to prevent their crisis-fighting plans from unraveling less than a week after they were hammered out. The euro area’s debt crisis will likely take center stage at the G-20, raising the stakes for banks poised to play a greater role in Greece’s next bailout.

The EU plan calls for Greece to adopt further austerity measures in exchange for a new infusion of official funds and a subsidized bond exchange. It also increases the firepower of the EU’s main rescue fund in a bid to limit contagion to Spain, Italy and other euro-area nations.

Banks would not consider providing debt relief to other countries such as Portugal caught up in the crisis, Dallara said on a conference call with reporters today. Greece’s circumstances justify a “unique approach” that should not apply to other sovereigns.

No Need

“We do not see the need, nor would we be willing to be involved in or engaged in, discussions of debt reduction for other countries,” Dallara said, speaking from Washington. He said the debt swap and official rescue program for Greece is needed to give Greece a chance to adjust its economy more gradually and ease the hardships on Greek citizens.

Portugal is on a “path of adjustment” and making changes that will lead to renewed growth and investment, he said. Dallara also was optimistic that Spain’s new government “will be able to build on the progress that has been made, particularly over the last year” after the Nov. 20 elections.

The People’s Party, which has pledged deeper austerity measures without specifying where it will axe spending, is set to win the largest majority any Spanish government has secured since 1982, a poll in El Mundo showed yesterday. Prime Minister Jose Luis Rodriguez Zapatero isn’t seeking re-election.

‘Grim’ Outlook

Dallara called on the G-20 to look for ways to promote economic growth, noting a “grim” unemployment outlook in the U.S. and Europe. He also urged the European Central Bank and others to provide more liquidity support for Greek banks, who he said have helped to finance Greece’s economy through bond purchases and private-sector lending.

The bank-recapitalization accord sets a June 30, 2012, deadline for lenders to reach core capital reserves of 9 percent after writing down their sovereign-debt holdings. Banks below that target would face “constraints” on paying dividends and awarding bonuses.

Banks are likely to decide that the costs of raising capital are “prohibitive,” Dallara said in his letter to the G-20. Rather than accept forced injections, banks are more likely to sell risky assets and cut back on lending, which will make it harder for countries on Europe’s periphery to access capital markets.

“The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds,” Dallara said. “This is contrary to the goal of stabilizing and underpinning the outlook for sovereign debt in Europe.”

New Requirements

If banks acted to meet the new requirements relying only on retained earnings and a reduction in credit supply, “overall credit exposure to the euro-area private sector would need to decline by at least 5 percent,” he said. “It is essential that the higher European capital requirements are a temporary measure as intended, not sustained over time and not seen as a new standard to be imposed more widely.”

BusinessEurope, a federation of European employers, today endorsed last week’s bank plan as well as the EU’s overall crisis-fighting strategy. The group also said the plan is the “best opportunity” for Greece to right its economy.

“We continue to believe the agreements regarding bank recapitalisation, extending the EFSF and improving the sustainability of Greek borrowing alongside commitments from all member states to implement recommendations regarding budgetary policy and structural reform, represent essential steps,” wrote Jürgen Thumann, president of the employers’ group, in a joint letter with Laurence Parisot, president of the business lobby Medef.

‘New Investment Capital’

The IIF renewed its call to continue work on the debt swap, even as Greek Prime Minister George Papandreou seeks to put the new rescue program to a parliamentary vote and a popular referendum. The debt swap, combined with Greece’s budget reforms and more EU and International Monetary Fund money, would help Greece return to a more sustainable and independent debt path.

“This would also help bring in new investment capital and unlock market access -- possibly as early as 2015,” Dallara said. “This would greatly reduce the burden on the official sector and the European taxpayer of providing perpetual support for Greece.”

The outline of the bond exchange calls for banks and other investors to exchange their holdings at 50 percent of their face value. The new bonds would be partially backed by collateral guaranteed by the European Financial Stability Facility or another AAA rated lender. Details on timing, eligible maturities and coupon rates haven’t been decided.

‘Significant’ Risk

As Europe proceeds with its crisis-fighting efforts, the European Central Bank needs to continue its secondary-market purchases of government bonds so markets and the economy can recover , Dallara said. The IIF said the ECB should consider lower interest rates as Europe faces a “significant” risk of recession that could spill over to the world economy.

“It is essential that all parties come together behind the continued active role of the ECB in the secondary government bond market,” Dallara said. “We would also emphasize that lower ECB policy rates at this point would enhance market stability as well as help bolster faltering regional economic growth.”

The U.S. budget debate is an area of “significant concern,” and some major emerging-market nations face slower growth and more inflation, the IIF said. The G-20 will need to coordinate its economic and regulatory policy objectives to put the world on sounder economic footing.

“It is essential for the official sector to begin viewing the banking system as an indispensible partner in fostering recovery, rather than an adversary on which it is necessary to impose ever more punitive measures,” Dallara said.

--With assistance from Emma Ross-Thomas in Madrid. Editors: Patrick G. Henry, Jones Hayden

To contact the reporter on this story: Rebecca Christie in Cannes at Aaron Kirchfeld in Frankfurt at

To contact the editor responsible for this story: James Hertling at

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