October 5, 2011 / 4:44 PM / 6 years ago

As Europe bank recap talk builds, who needs it?

LONDON (Reuters) - Banks in France, Italy and across Europe are under renewed scrutiny for signs they will follow Dexia and need state help as policymakers talk up the need to raise capital to halt a euro zone crisis.

The bailout of Belgian-French bank Dexia has intensified pressure to improve bank solvency, in a bid to break a vicious circle of negative news from indebted governments and troubled banks feeding on each other.

“Solving the sovereign crisis today is unrealistic because we are in the midst of a political crisis. So an interim solution is to make the banks safe and put precautionary capital into the banking system, to recognize people’s concern and say ‘Here is capital to reassure the bond market’,” said Mike Harrison, bank analyst at Barclays Capital.

After months of inaction, the EU has begun working on a scheme to shore up lenders. With banks shut out of funding markets and seeing costs to insure their debt rising, calls for action have built.

European commissioner for economic affairs Olli Rehn said banks’ capital positions “must be reinforced,” and German Chancellor Angela Merkel said on Wednesday that she was willing to act quickly to recapitalize the sector.

That has left investors fretting over potential weaklings.

Dexia was particularly vulnerable after failing to solve its problems after a 2008 bailout, and has long been seen as facing more acute capital and liquidity problems than rivals, but its troubles still held a warning for others.

Eight mid-tier banks that failed a “stress test” in July have been told to raise cash this year, and a further 16 lenders must show plans to improve solvency by the end of this month, and all could need more than originally planned.

They include seven Spanish banks, including Bankia, Sabadell and Bankinter, Italy’s Banco Popolare and two each from Germany, Greece and Portugal.

The fear in the market — reflected by elevated bank-to-bank lending rates — is that bigger names are also feeling the squeeze, and more capital is needed to reassure investors and re-open funding markets for them next year.

French banks including Societe Generale and BNP Paribas were hammered last month by worries about their higher reliance on short-term wholesale funding.

Problems at the banks and at sovereign borrowers have become increasingly intertwined, with the risk of losses on bonds issued by peripheral euro zone countries heightening the need to recapitalize lenders.

Requiring banks to hold core capital of 7 percent under a two-year recession and applying market prices for losses on government bonds in Greece, Ireland, Portugal, Spain and Italy would see 46 banks need to raise a total of 82 billion euros ($109 billion), according to Reuters estimates.

Societe Generale, Italy’s UniCredit, Germany’s Deutsche Bank and Commerzbank and Britain’s Royal Bank of Scotland would all need over 3 billion euros, the data show.

But crunching that data alone is flawed — Dexia, for example, ranked 11th out of the 91 tested in the stress test.

Alan Wilde, head of fixed income and currency at Baring Asset Management, said rumors were rife about where trouble lies in the sector, but markets “are probably looking in the wrong places for the next failure.”

The International Monetary Fund reckons Europe’s banks could need to recapitalize to the tune of 200 billion euros, which the head of its European department on Wednesday said was not because the industry was too weak, but was needed to restore investor confidence and boost growth.

Credit Suisse analysts estimate banks may need 400 billion euros of capital by 2012 to fill a hole left by a recession and sovereign losses, and JPMorgan this week estimated banks face a 227 billion shortfall under a stressed scenario, with UniCredit, Deutsche Bank, Lloyds, Societe Generale and Barclays all in need.

Banks have better capital and liquidity positions than in 2008 — they have received 420 billion euros of capital in the last three years — and more central bank support is in place to ease any liquidity strains that do emerge.

But governments have less firepower for bailouts than in 2008, and private sector investors seem more reluctant to take a bet on the sector in the face of depressed returns and high risks.

Recapitalizing banks could take place next month, when the EFSF euro zone rescue fund is up and running, said Morgan Stanley analyst Huw van Steenis. The majority could come from government injections, to be followed by banks raising funds to repay it.

But the capital moves will only work if they are in tandem with other efforts, he and other analysts said.

The European Central Bank could extend the duration of funding on offer to two years, re-activate a covered bond buying program, and potentially buy unsecured bank bonds.

($1 = 0.751 Euros)

Additional reporting by Sinead Cruise and Sarah White; graphics by Vincent Flasseur; Editing by Will Waterman

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