Written by Hilary Barnes
If the US Congress had not raised the debt ceiling and the US had defaulted on its loans, no one would have been too surprised if the world were hit by a new systemic financial crisis, with “systemic” defined as a 40% decline over six months of the aggregate stock index. Since the legislation passed only “fixes” the debt ceiling and funding problem for a few months the same potentialities remain “on the table”. This makes the timing of the publication of a paper by the French business school IESEG particularly pertinent.
The paper, The recapitalization needs of European banks if a new financial crisis occurs, by Eric Dor, draws on estimations based on the estimated capital shortages of big individual banks published by the Volatility Laboratory (VLAB) of New York University Stern Business School and the Center for Risk Management (CRML) of Lausanne.
It indicates European highly indebted European governments face the mother of all crisies. Governments would not have the money to recapitalise the banks and the sums curently on the table for collective rescues of the banks by the European countries are no where near big enough to meet demands that would arise.
France would have the biggest problem of all, with a need for bank refinancing of €240bn or about 11.6% of GDP. Bail-ins would be the order of the day, the paper argues.
The UK’s Barclays Bank, with a refinancing need of between €94.8bn (VLAB) and 65.8bn (CRML) would be the bank with the biggest problem of them all, followed by Deutche Bank, €82.8 / 78.1bn, France’s Credit Agricole €82.6bn / 78.5bn, BNP Paribas €61.2bn / 55.4bn, and Societe Generale €51.1bn / 45.6bn, Royal Bank of Scotland €61.0 / 39.4bn, and Itay’s Unicredit €30.5bn / 26.4bn.
The IESEG paper concludes :
“The results show that the potential recapitalization needs of the banking sector would be extremely high for certain European countries like France, in the event of a new systemic financial crisis. Given their already high level of indebtedness, increasing the public debt ratio by 5 to 10% would certainly trigger a sharp increase of interest rates on government bonds. An extremely severe fiscal austerity should be implemented, leading to a new recession. The current means of the European Union seem to be insufficient as compared to the huge potential capital shortages and recapitalization needs that have been reported for the banks. The possibility of direct recapitalizations of the biggest banks by the ESM is subject to a very strong conditionality and is limited to a total amount of 60Billions €.
“There remains the possibility to rely on a special programme of ESM which lends money to the governments to recapitalize the banks with a conditionality that focus on this industry, like what is currently implemented in Spain. Anyway these bailouts by ESM simply mutualize the risks and deteriorate the debt ratios of all the European countries. The current prospects of a European banking union offer limited means to address the loop linking banks and governments. Therefore bail-ins should certainly be conducted in the event of a new systemic crisis, at least for 8% of the liabilities according to the results of current negotiations. The problem is that the new resolution fund, which is supposed to finance restructurings, must be financed by the banks through a tax of 0.5% of guaranteed deposits and needs at least 10 years before reaching its target size.”