Who's next?
October 21, 2011
The return of the global financial crisis took its first victim on October 10 - Belgian-French Bank Dexia was broken up and partially bought by the Belgian government. Now fear is spreading with everyone asking: Who's next?
"Only those institutions that are directly impacted really know. We can only assume what could happen if Greek government bonds lose 50 to 60 percent of their value and need to be written off," said Michael Schröder from the Center for European Economic Research.
Schröder believes a haircut for Greece is becoming ever more certain. Banks that own high levels of Greek government bonds could face bankruptcy, and other banks could be dragged down as well.
A subsequent collapse of the financial system could then force countries to their knees. In the end, the world will fall into a deep recession. All this is possible and one reason why politicians need to do everything in their power to make a Greek haircut possible, according to Schröder.
New stress test
The European Banking Authority (EBA) is currently conducting a new bank stress test. The agency is demanding that banks have a core capital quota of 9 percent. But that, according to Schröder, could lead to a capital shortage of about 200 million euros ($275 million).
Moreover, the truly big risks were not considered in the previous two stress tests, according to Schröder. "No one considered, for instance, that European countries could also go bankrupt, leaving their creditors with empty hands," he said.
But if banks have to deposit securities for government bonds, then most banks in Europe could be unable to meet the capital requirements and pass the stress test. What happens then?
Policymakers are divided. The German government believes banks need to raise capital on their own and should only be helped if they fail to raise enough. Only as a last resort should the European Financial Stability Facility (EFSF) be considered.
If it were up to France, either the EFSF or governments should help banks recapitalize themselves - according to the "watering-can principle." This approach should prevent French banks from being branded as the sole recipients of state aid. After all, they own far more Greek government bonds than German banks and have much more to lose in the event of a Greek default.
Watering cans and haircuts
German banks have continuously reduced their level of Greek government bonds over the past two years. According to the Bank for International Settlements, German Banks had Greek promissory notes worth 17.5 billion euros at the end of June, of which Deutsche Bank carried 1.15 billion euros. The bank could endure a loss of value of 60 percent. And that is the reason why Germany's biggest bank opposes a forced recapitalization and is willing to take legal action.
Whether a forced recapitalization will come is unclear. There is no legal basis for the move, as the strict equity capital requirement of the new Basel III framework doesn't come into effect until 2019, according to experts.
But that hasn't kept the US government from taking action. Shortly after the collapse of the Lehman Brothers investment bank, Washington partly nationalized troubled banks with $245 billion, whether or not they wanted this support.
Perhaps the Greek haircut could be a crisis big enough to override all valid rules. As a result, France could also lose its top credit rating and be forced to pay more to borrow money, further adding to its debt. To avoid this, the French government wants the EFSF to be able to buy government bonds with no limitations. The German government is fiercely opposed to this idea.
Daniel Gros, director of the Center for European Policy Studies in Brussels, told the German newspaper Handelsblatt, "It's all about France, and the question if and how Germany finances France via the EFSF."
Author: Zhang Danhong (jrb)
Editor: Ben Knight