German bankers railed Thursday against European Union proposals that would force the Continent's banks to raise capital and further write down the value of Greek debt on their books, arguing that the moves themselves could force the sort of financial crisis that Europe's leaders are working to avoid.
Deutsche Bank AG's chief executive, Josef Ackermann, cautioned Thursday that a credit crunch could result if Europe's leaders enact higher capital levels for banks and big haircuts on sovereign debt.
The five major German banking associations also sent a letter to German Finance Minister Wolfgang Schäuble, warning against phasing in regulatory requirements too quickly. "It can't be in the interests of the stabilization of the financial markets to fabricate an alleged weakness through an artificial intensifying of capital requirements," the banking associations wrote.
The European Commission on Wednesday outlined proposals to shore up European banks in the face of the region's escalating sovereign-debt crisis, calling for a more-stringent review of the banks that will likely result in broad recapitalization to dispel doubts about the region's banks. Those with inadequate capital will need to raise it, from private sources if possible and from governments as a last resort, the commission said.
The European Banking Authority, the pan-European Union banking regulator, suggested that the threshold for core Tier 1 capital requirements—the ratio of a bank's core equity capital to its total risk-weighted assets—could be raised to 9%, according to a confidential communication to national banking authorities, an EU official said Wednesday.
This summer's stress tests of European banks set the threshold at 5%. The current European banking regulations, so-called Basel II, requires a minimum core Tier 1 capital ratio of 2%.
Several analysts said Thursday they believe a more likely threshold would be 7% to 9%.
Under these guidelines, teams of analysts estimated Thursday that Europe's banks face a shortfall of between €200 billion and €300 billion ($276 billion to $414 billion) in capital in scenarios in which troubled nations' sovereign debt would be marked down to market value.
Under scenarios in which a severe sovereign-debt crisis results in a spillover into other business areas in troubled countries, some analysts said European banks could face a capital shortfall of as much as €420 billion.
Deutsche Bank alone could face an immediate €9 billion capital shortfall under higher capital levels, said people familiar with the matter.
On Thursday, Fitch Ratings placed a negative ratings watch on Deutsche Bank's long-term issuer default rating of AA-minus, saying it will examine the bank's capacity to achieve its target capitalization, which will be affected by the introduction of new capital requirements under Basel III regulations.
Deutsche Bank, Germany's largest bank by any measure, is one of the few that could still raise capital from investors, analysts agree, but it would be an expensive and dilutive process. Government help in the form of capital injections or guarantees would likely be needed.
Mr. Ackermann, who also leads the global association Institute of International Finance, has been instrumental in negotiating private involvement in Greek debt restructuring. He said the potential new capital rules are focusing on the wrong issues and will likely harm the economy further.
The "question is whether banks will be able to ensure this financing [of European businesses] in the future, or whether they will be practically forced to implement restrictions [on lending] due to possible debt haircuts in the euro zone," Mr. Ackermann said at a business conference in Berlin. He said euro-zone leaders shouldn't place additional regulatory pressure on banks that could "lead to overall negative consequences for the economy."
The euro zone is already at risk of recession as early as the end of 2011 and early 2012, some analysts say. Even Germany, whose export-driven rebound powered the euro zone's recovery in 2010 and early this year, faces a sharp slowdown, one that would be compounded in the event of a credit crunch.
Germany's gross domestic product will expand 0.8% next year after growing nearly 3% in 2011, Germany's main economic think tanks said in a report Thursday.
"The debt crisis in Europe risks becoming a banking crisis, because many banks hold large quantities of the debt of crisis-hit states," said the group of eight think tanks, which include the Munich-based Ifo and the Institute for Economic Research in Halle. "This is increasingly weighing on German growth."
Meanwhile, governments are also pressuring banks to take bigger write-downs on their Greek debt in a move that would allow the private sector to help share some of the risks of bailing the country out. Under a deal cut this summerbetween the EU, the European Central Bank and the International Monetary Fund, euro-zone leaders and banks agreed to voluntarily write down the value of Greek sovereign debt on their books by 21%.
But with Greece's financial position worsening, euro-zone officials are now discussing a haircut of as much as 60%, in line with the current price of bonds.
While Greek and Portuguese banks would be hardest hit, large lenders such as Société Générale and UniCredit would also face major problems, analyst say. Banks are currently trying to negotiate a voluntary write-down of 40%, according to people familiar with the negotiations.
The ECB, which has long been skeptical of the benefits of private involvement in Greek debt restructuring, warned again Thursday that private-sector involvement could cause contagion and "put at risk the financial stability" of the euro zone, triggering a need for large-scale bank recapitalization.
The ECB worries that forcing banks to take a hit on their government bond holdings could affect balance sheets throughout the euro zone, and force governments to spend public funds to shore up banks, adding to deficits and threatening credit ratings.
"From a systemic risk perspective, the issue clearly is that it's impossible to consider restructuring the Greece debt in such a harsh way without considering the contagion effects to the more systemically important nations," said Stephen Dulake, head of European credit research and strategy at J.P. Morgan in London.
The EBA will update assessments of banks' capital needs based on information disclosed by banks during stress tests carried out in the summer, this time with more negative scenarios and higher capital requirements. Results are expected in time for the coming European leadership summit on Oct. 23.
Most of Thursday's analyses of bank recapitalization factored in higher capital requirements and extra hits to Spanish and Italian debt, where purchases by the ECB have helped stabilize prices. Taking into account major sovereign haircuts and other spillover effects, based on guidance from the IMF, the total recapitalization number could top €420 billion, according to estimates by J.P. Morgan.
The analyst scenarios use EBA data as of the end of 2010. The new EBA scenarios will contain updated information from the first half of this year. Many banks have already factored in 21% voluntary haircuts on their Greek exposure, with RBS taking a 50% hit and Deutsche Bank marking its Greek exposure to market value in the third quarter.
Credit Suisse analysts estimated that 66 European banks would fail the new European Banking Association stress tests if required to maintain a 9% core Tier 1 capital ratio, with RBS, Deutsche Bank and BNP needing the most capital.
But injecting capital into banks before it is clear they absolutely need it is a dangerous and backward plan, said Omar Fall, a UBS banking analyst in London. Under the harsher scenarios, a bank like Société Générale could require €14 billion to €15 billion in capital.
"Ultimately if the EBA comes out with a number, that number will have to be filled," he adds. "It would hang like a noose in funding markets over any bank that doesn't address it. Again, the question is only what form the capital takes and where it's coming from."
Deutsche Bank already faces a capital shortfall of as much as €15 billion in meeting new regulatory requirements over the next several years, analysts estimate.
Mr. Ackermann has stressed he will not raise capital while the bank's share prices are so low. Deutsche Bank shares closed down about 5% from Wednesday at €27.83 in Frankfurt trading, down by about one-third from a year ago.
But the bank could be forced to raise capital if it fails the ongoing stress tests.
European banks do need more capital and have been working to attain that, Mr. Ackermann said in his speech.
"It appears doubtful to me that an increase in the capital ratios of European banks overall can be considered an efficient measure to master the sovereign debt crisis," he said. "It is not the capital funding of banks that is the problem but rather the fact that government bonds have lost their status as risk-free assets. The key to solving the problem thus lies with the governments, specifically in restoring trust in the solidity of state finances."
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