Dec. 9 (Bloomberg) -- European regulators warned banks not to cut lending or inflate capital levels artificially as they ordered the region’s financial firms to raise 114.7 billion euros ($153 billion).
The European Banking Authority told lenders yesterday to bolster their Core Tier 1 capital ratios to more than 9 percent of risk-weighted assets by the middle of next year to reassure investors the region’s banks can withstand the debt crisis. The EBA told banks to raise the money from investors, retained earnings and lower bonuses. Failing that, companies may sell assets, provided the disposals don’t limit overall lending to the “real” economy, the EBA said in a statement.
The measure sets up a clash between lenders and regulators trying to avert a potential credit crunch. The Bloomberg Europe Banks and Financial Services Index has slumped 33 percent this year, leaving bank shares trading at an average discount to book value of 39 percent. That makes it more attractive for banks to sell assets than stock.
“Who is going to pump money into banks in the euro zone in its darkest hour when their shares are already trading at a huge discount to book value?” said Bob Penn, a partner at Allen & Overy LLP in London. “Banks will deleverage because they feel that they have no other choice.”
Bankers and lawyers question whether the EBA will be able to enforce its lending rules and halt a process by which European banks may shrink their assets by 2.5 trillion euros over the next 18 months, according to estimates by Morgan Stanley analysts led by Huw van Steenis in London.
Banks have until Jan. 20 to devise a plan for how they will reach the target. National regulators will then be responsible for enforcing the process.
“This will be a real test of how much authority the EBA actually has with national regulators,” said Jacob Ghanty, a London-based partner at Berwin Leighton Paisner LLP. “It is not just telling credit institutions where they need to get, but also how to get there.”
German banks were ordered to raise 13.1 billion euros of capital, more than the regulator estimated in October, after some European sovereign bonds tumbled in the three months through September. Deutsche Bank AG, the country’s largest lender, must raise 3.2 billion euros, while Commerzbank AG has to boost capital by 5.3 billion euros, according to the EBA. Spanish banks were told to raise 26 billion euros and their Italian counterparts 15.4 billion euros.
The BdB, Germany’s banking lobby group, yesterday denied the country’s banks were undercapitalized and warned of negative consequences for the European economy from the stress test. Michael Kemmer, the association’s general manager, said the EBA had lost some credibility with its latest announcement.
Banks may also be prohibited from adjusting their internal risk-weighting models as a shortcut to boosting regulatory capital, a process known as risk-weighted asset optimization. Lenders can inflate capital levels by declaring the assets they hold less risky under the Basel Committee on Banking Supervision’s rules.
“Reductions in risk-weighted assets due to the validation and roll-out of appropriate internal models to additional portfolios should not, in general, be allowed as a means of addressing a capital shortfall unless these changes are already planned and under consideration by the competent authority,” the EBA said.
European firms, governed by Basel II rules, use their own models to decide how much capital to hold based on an assessment of how likely assets are to default and the riskiness of counterparties. By claiming those assets are less risky today than yesterday, banks can instantly boost their capital ratio.
Contraction in Lending
Banco Santander SA, Spain’s biggest bank, was ordered to raise 15.3 billion euros, more than any other European lender. The company has said it will generate capital from its profits and find 4 billion euros by optimizing risk-weighted assets and rolling out internal models. The bank may also reduce the capital shortfall with about 8.5 billion euros of convertible bonds and sales of assets in Colombia and Chile.
“We have seen a contraction in lending over the past three months,” said Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc in London. “I don’t expect that trend to revert.”
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