Europe's Banking System: How Weak Is It?

To be diplomatic, let's simply say that opions differ over how weak Europe's banking system really is. Over the weekend Christine Lagarde, former Finance Minister of France and now the head of the IMF, said that a significant amount of new capital should be provided to European banks in order to help contain contagion:

A Call to Arms



The world economy, [Lagarde] said, was entering a “dangerous new phase” driven by a sense that “policymakers do not have the conviction” to take decisions that are needed. That must change, and now. Ms Lagarde laid out a bold to-do list to support growth, including a forced capital injection into Europe’s banks, aggressive new action to deal with America’s foreclosure crisis, and a broad rebalancing of fiscal priorities.



The most headline-grabbing prescription was for Europe’s banks. More capital, Ms Lagarde argued, was essential to “cutting the chains of contagion” in the euro crisis. Without it there could easily be “the further spread of economic weakness to core countries, or even a debilitating liquidity crisis”. She called for what would essentially be a European version of America’s policy for its biggest banks in 2008—a mandatory capital increase using public funds if necessary. Those funds could come from the European Financial Stability Facility.

But this suggestion was rebuffed by many political and financial leaders in Europe:

Europe officials defend banking systems



MADRID — Top European officials defended the health of the continent’s financial system Monday, trying to stem concerns that Europe’s slowing economy and high levels of government debt may cause some of its banks to fail.



In separate statements European Central Bank President Jean-Claude Trichet and European Economic and Monetary Affairs Commissioner Olli Rehn said banks within the 17-nation euro currency zone have been steadily raising the amount of capital set aside as a cushion against losses and will not face the sort of cash crunch that helped trigger the recession in 2008.

Meanwhile, ground zero for possible banking crisis contagion (Greece) had its own set of developments. For one, the second and third largest banks in Greece announced plans to merge, along with, crucially, an injection of fresh capital from Middle East investors:

Alpha to Acquire EFG Eurobank to Create Biggest Greek Lender



Aug. 29 (Bloomberg) -- Alpha Bank SA, Greece’s third- largest lender, will buy EFG Eurobank Ergasias SA and increase capital by as much as 3.9 billion euros ($5.7 billion) to ride out a deepening recession and the country’s sovereign debt crisis.



...Following the merger, the bank plans to strengthen its finances with a 1.25 billion-euro rights offer, a 500 million- euro convertible note to be taken up by Qatari-backed Paramount Services Holding Ltd., and more than 2.1 billion euros of internal measures, the statement said. That will help give the lender a core Tier 1 capital ratio of 14 percent, even after accounting for writedowns of Greek government bonds, the companies said.

Meanwhile, the National Bank of Greece (NBG), the largest bank in that country (18% owned by the Greek government), reported a large loss due to a writedown of part of its stock of Greek government bonds:

National Bank of Greece Posts EU1.31 Billion Loss on Bonds



Aug. 30 (Bloomberg) -- National Bank of Greece SA, the country’s biggest bank, reported a first-half loss after writing down its holdings of Greek government bonds.



The net loss was 1.31 billion euros ($1.89 billion), compared with a profit in the year earlier period of 146 million euros, according to a faxed statement from the Athens-based lender today. National wrote down the value of its bonds by 1.645 billion euros, according to the statement. Stripping out that figure, profit was 29 million euros.

One worrying statistic reported along with this news about the write-down was the continued shrinkage in deposits kept with NBG. In fact, deposits with the Greek banking system as a whole have fallen by almost 10% so far this year. And that's why Lagarde's suggestion was rejected so forcefully by leaders in Europe. Because if people start calling into question the viability of the big European banks and start withdrawing money from them as a result, the euro-zone debt crisis will take on a whole new dimension of horribleness.