Wednesday, October 5, 2011

Germany's Merkel backs plans to recapitalize banks, but how much capital do they need? (updated)

A Telegraph article reports that Germany's Chancellor Angela Merkel backs plans to recapitalize the Eurozone banks.

The key questions are:  how much capital do the banks need and will there be disclosure of each bank's current asset and liability-level data so that market participants can confirm the adequacy of this additional capital injection?

Confirmation of the adequacy of the capital injection is critically important to restore market confidence because the mere discussion of another round of capital injections in the Eurozone banks clearly shows that the first round of capital injections was inadequate.

As previously discussed on this blog, potential recapitalization amounts range from the single digit billion euros (based on the EU financial regulators stress tests) to 200 - 300 million euros (based on the IMF's analysis) to maybe as much as 2 trillion euros (based on BlackRock Larry Fink's comment).

Regardless of what number is selected for recapitalizing the banks, market participants and Germany's Merkel are going to want to be able to verify that this recapitalization is sufficient to restore and maintain bank solvency.  The only way to do this is if each bank discloses its current asset and liability-level data.

If regulators do not require banks to make this disclosure, market participants and Germany's Merkel could easily conclude that the regulators are hiding something and that the banks are in fact not adequately capitalized.  After all, there is no reason not to disclose this data unless the banks are hiding something.
The German Chancellor's intervention on Wednesday rallied European markets after fears that EU's determination to prop up banks was wavering after a meeting of finance ministers on Monday failed to take a decision. 
"I think it is important, if there is a general view that the banks are not sufficiently capitalised for the current market situation, that one does it," she said following talks in Brussels.  Chancellor Merkel said that she was ready to support and to decide on a eurozone bank capitalisation plan as early as October 17, at an EU summit. 
"Germany is prepared to move to recapitalise. We need criteria. We are under pressure of time and we need to take a decision quickly," she said. 
Actually, as your humble blogger has repeatedly pointed out, Eurozone policymakers are not under time pressure to inject capital into the Eurozone banks.

Eurozone policymakers are under time pressure to put in place a mechanism for determining how much capital each bank needs.

Only after the size of the capital shortfall has been determined is it appropriate to talk about how and if each bank will be recapitalize - which banks will recapitalize themselves through retained earnings, which banks will be recapitalized by raising equity from the capital markets, which banks will be recapitalized by their host governments, and which banks are so far underwater that they will be closed.

The "how to" roadmap for doing this involves the following steps:

  1. Each bank discloses its current asset and liability-level data to all market participants;
  2. Market participants analyze this data and determine how much capital each bank needs;
  3. Working with market participants, the regulators determine appropriate strategy for recapitalizing each bank; and 
  4. Banks recapitalized.
Please note, these steps will not be completed in 5 weeks.  However, that is not what is needed to restore confidence in the market.

What is needed is that the market sees the Eurozone governments committed to a path that will address and end the solvency crisis.

... Germany is said to support a move by the European Banking Authority to raise minimum capitalisation levels, a change that would lead to a need for financial support for banks with exposure to Greek or other sovereign debt risk.... 
Germany's intervention soothed markets but will intensify pressure on France. 
France, with banks that are among the most exposed, including its stake in Dexia, is opposed to recapitalisation. Nicolas Sarkozy, the French president, is concerned that the huge sums he might have to pay out could threaten the French AAA sovereign debt rating ahead of elections next year.
Using my approach, it is not clear that governments will have to inject huge sums of money in their banking systems.  Private investors are likely to put up the money when they can assess the risk of each bank.
"I think it will be a very important signal to the international financial markets," she said.
The key is to send the right message.  My modest proposal is the message that needs to be sent.
"There's just news of discussions about a possible bank recapitalisations, there's no details yet," said Kasper Kirkegaard, currency strategist at Danske in Copenhagen. "There's a high risk of a further sell-off if we don't get details on this soon."
The details that need to be laid out is a credible plan for addressing the need to recapitalize the banks.


A Wall Street Journal article discusses a 'plan' to restore investor confidence in Eurozone banks.  Under the plan, each EU nation and its financial regulators are now suppose to tell how much capital each bank actually needs.

Currently, the plan lacks verifiability by market participants.  Instead, market participants are suppose to simply believe these numbers.

This plan is highly unlikely to restore confidence.  At a minimum, it excludes two key ingredients to restoring confidence.  These ingredients are current asset and liability-level disclosure and investor participation in the determination of how much capital each bank needs.

Germany is putting pressure on other euro-zone governments to declare how they would recapitalize their banks if the need arose, as part of a concerted effort to repair investors' battered confidence in European banks....

German officials hope that a coordinated demonstration by euro-zone governments that they have contingency plans for their banks in place would calm financial-market fears of a banking crisis in the region....
As well as alleviating such funding strains, German officials hope that a system of backstops for banks would give the euro zone more freedom to deal with Greece's teetering debts—including the option of restructuring Greek bonds. 
Investors fear that some European banks would struggle to digest the losses that would follow from a major Greek debt restructuring, unless the banks receive capital injections from national or European authorities....

Banks should seek to raise capital first from private investors, and from national authorities if they can't tap the market, she said. If national authorities don't have the necessary resources, banks should turn to currency bloc's main bailout fund, the European Financial Stability Facility, she said....

Germany has said in recent days that it stands ready, if necessary, to reactivate its national banking bailout fund, which was set up in 2008 but is now closed to new aid requests from banks. Reopening the fund would require approval from Germany's parliament, but Berlin officials believe they could get that authorization quickly.

Germany professes confidence that its own banks, which have so far avoided the worst of the recent funding strains, don't need more capital. But Europe's biggest economy wants the single-currency bloc to send a united, reassuring signal to financial markets about its banks.

German officials have complained that some other governments haven't put in place national contingency plans to support their banks. German Finance Minister Wolfgang Schäuble was frustrated at the lack of progress in some countries when European finance ministers discussed the issue in Luxembourg early this week, according to people familiar with the matter....

France's government, however, is reluctant to reactivate its banking bailout measures dating from 2008, according to people familiar with the matter. Paris is deeply worried about losing its triple-A credit rating if the rating agencies decide the country can't afford any costly new bank-support measures, these people say....

French banks are also against announcing a new national banking backstop, for fear that it could spook financial markets already worried about French lenders' exposure to indebted Southern European countries.

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