Europe's banks will need to find at least €100-billion of new capital by next summer under a new plan to help stabilize their operations, raising troubling questions about where that money is going to come from.
The tools those banks would normally have at their disposal to raise capital – selling off assets or issuing more shares – are fraught with problems as Europe struggles to prevent a sovereign debt crisis from crippling its banking system.
European Union officials are expected to tell banks to boost their tier-one capital ratios to more than 9 per cent this week, which the European Banking Authority estimates will require at least €108-billion ($150.8-billion Canadian) of new funds. In addition to the higher ratios, EU leaders also want the banks to accept losses of more than 50 per cent on Greek debt they hold.
Bank executives now face the daunting task of figuring out where to get that capital from. Lenders looking to shore up their tattered balance sheets by selling off assets will be wading into a market with few buyers. Canadian banks, which are among the most capitalized in the world, say they have been fielding dozens of offers to buy European bank assets but are being selective, as our institutions in the United States.
A faster solution – to issue equity – is facing opposition from European bank leaders because it would dilute their shares considerably and drive down the stock prices. But at a time when the markets are cool to both preferred and common stocks in the European banks, there are questions as to whether they could execute a successful share issue right now. Analysts suggest that any European bank issuing large numbers of new shares to shore up capital could be tantamount to dumping them on the market at depressed prices.
Shares in the region's banks have fallen an average of 40 per cent since February as fears emerged that sovereign debt defaults in countries such as Greece, Spain and Italy would ripple throughout the sector.
"Say the European banks go out to the market and try to raise capital – they're not going to be able to raise things like debt and preferred shares, because people aren't really going to want that type of stuff," Canaccord Genuity analyst Mario Mendonca said. "But does anybody really want their common equity either?"
There might also be hidden problems in trying to raise capital by selling assets. Larger banks with the balance sheet to buy up chunks of a struggling European lender may be reluctant to grow their operations. New regulations that require the world's biggest banks to carry extra capital depending on how big they are could act as a deterrent for big players to go shopping. For example, if Bank of America had the opportunity to buy a large credit card business in the U.S. from a European player, it would also have to prepare to hold more capital against those riskier assets.
"Under the new global capital rules, the bigger you are, the higher the capital charge," Mr. Mendonca said. "So how do you encourage someone who is on the bubble to get bigger, when they know it just means they're going to post more capital?"
In a situation reminiscent of 2008-09 during the U.S. banking crisis, European lenders are also said to be reaching out to private equity players and sovereign wealth funds for assistance. But some of those investors, such as sovereign wealth funds in the Middle East, took a hit when they bought early stakes in U.S. banks in 2008 and are concerned about getting burned on propping up European banks.
Increasingly, a government bailout of banks similar to the Troubled Asset Relief Program introduced by the United States, which saw the U.S. government prop up banks in exchange for shares that delivered attractive dividends, is seeming like the most likely scenario for Europe.
"I don't really understand why they haven't done it yet," said Rob Wessel, managing partner of Hamilton Capital Partners in Toronto, suggesting that several countries could act on their own to stabilize their banks.
Deep political divisions in Europe may prevent that solution from being employed quickly. The two biggest power brokers in the region, France and Germany, disagree on what should be done. French President Nicolas Sarkozy wants the EU to shoulder the bailout of banks holding large amounts of sovereign debt, to avoid French banks having to feel most of the pain. German Chancellor Angela Merkel doesn't want Germany to have to pick up the tab.
The ability of European governments to shoulder the burden of raising capital for banks, in a share purchase agreement for example, is also in question. Were governments to put in money for the recapitalization, it would only make the tenuous debt situation in Europe worse in several countries.
However, France's bank governor said he believes French banks will need €10-billion to meet the new standards, and won't require government support to meet higher standards being discussed by state authorities. "This is perfectly absorbable by the banks themselves," Bank of France governor Christian Noyer told reporters in France on Monday. "They can do it without state aid. There's no bank in particular that needs help."
European bank stocks gained Monday on Mr. Noyer's comments, and as leaders prepared to meet further this week to discuss possible solutions. Europe's benchmark banking index rose 2.2 per cent, led by French banks BNP Paribas and Societé Générale SA, which both rose over 6 per cent.