The Financial Crisis Returns Europe's Attention Shifts to Its Ailing Banks

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Part 2: Europe Mulls Forced Bailouts


Sources of liquidity are already starting to dry up. Since late July, US funds have withdrawn nearly 20 percent of their investments from French banks. Société Générale alone lost nearly €20 billion in financing within just a few weeks this summer.

The situation is even worse for Spanish and Italian banks, which have been largely cut off from this important flow of dollars for some time now. A few weeks ago, the US Federal Reserve and the ECB, together with the British, Swiss and Japanese central banks, joined forces to make dollars available to these banks until the end of the year. Without this regular intervention by the central banks, liquidity would have long since dried up.

Greek financial institutions have been forced to stop financing many domestic businesses and investments. Even many healthy companies now find it almost impossible to borrow money. "This is the death of the Greek economy," Greek Economy Minister Michalis Chrysochoidis grimly commented. The country's banks are first in line for any European bailout program.

Things look significantly better for German financial institutions thanks to the country's robust economic recovery. But banks such as the state investment bank Nord/LB in Hanover and the publicly-owned regional bank Landesbank Hessen-Thüringen (Helaba) have too little equity to weather a major crisis. Overall, German financial institutions reportedly need an extra €20 billion in capital.

Commerzbank was bailed out in 2008 with two injections of capital. It was only recently that Commerzbank CEO Martin Blessing returned the majority of the state guarantees that he had received from Berlin -- but he may have to turn right around and ask the German government for more money.

A Different Story

The Greek debts are not his major concern, though: Commerzbank lent €2.2 billion to the Greek government in late July, and an additional €900 million to Greek banks and other enterprises. "Commerzbank could reasonably withstand even a 100-percent haircut in Greece," says Merck Finck analyst Konrad Becker.

It would be a different story altogether, though, if Italy and Spain ran into greater difficulties in the event of a Greek default. The governments of both countries owe Blessing's bank a total of €11.6 billion. On top of that, there are loans and other financing measures for the private and banking sector amounting to nearly €19 billion.

Should the crisis actually escalate and debt restructuring also become necessary in Spain and Italy, "Commerzbank would certainly no longer be in a position to cope with this alone," says Becker. This would make Commerzbank a candidate for recapitalization. If necessary, the medicine will have to be administered forcibly.

A move to compel banks to increase their liquidity buffers, as is currently under discussion in Brussels, would meet with even more resistance from Deutsche Bank. "We are very well capitalized," said Deutsche Bank CEO Josef Ackermann at an analysts' conference last week in London. He explained in detail that the bank will be able to improve its capital base thanks to billions in anticipated profits, adding that by the end of 2013 Deutsche Bank intended to shed risky securities worth nearly €100 billion. At the same time, however, Ackermann had to admit that the bank will miss its profit target of €10 billion for 2011. Although the bank reduced its risks in Greece, Italy, Portugal, Spain and Ireland to €3.7 billion by late June, it's clear that if other euro countries besides Greece start spinning out of control, things could also get tight for the German market leader.

One analyst at JP Morgan has already put forward a scenario in which Deutsche Bank requires nearly €10 billion in additional capital. Moreover, the analyst argues that the bank's liquidity cushion may be insufficient once regulators introduce new provisions over the coming years. Ackermann cites big numbers in an effort to refute such criticism. He says the bank has obtained €180 billion in liquidity.

Soffin Relaunch

There is so much fear of a second banking meltdown that officials in the German Finance Ministry are working to redeploy a tool that already proved itself during the financial crisis of 2008 and 2009 -- the Special Fund for Financial Market Stabilization (Soffin). The fund was able to provide ailing banks with guarantees totaling up to €400 billion. This initiative expired in 2010 and is now only dealing with old cases -- but it would be easy enough to revive it: "All we would have to do is change the date in the text of the law," according to staff members working for German Finance Minister Wolfgang Schäuble. They also think that such a move would be approved by the parliamentarians of the parties in Germany's center-right coalition government.

The topic of bailing out the banks is at the top of the agenda across the European Union, and a fundamental decision on the issue was expected at the next summit of the 27 heads of state and government in Brussels, originally scheduled for Oct. 17-18. Due to ongoing differences between France and Germany, however, it has now been postponed until Oct. 23.

When it comes to banks, the Germans are pushing for all banks in the euro zone and the UK to have a standard capital ratio of, for example, 10 percent. Furthermore, experts in Brussels are considering introducing compulsory aid for banks. This contrasts with existing rules in individual EU countries that provide no means of bolstering recalcitrant financial institutions. According to the new concept, any bank that can't raise enough private capital would be financed from public coffers.

Sources in the German Finance Ministry say that these measures would be limited to banks deemed "too big to fail." In addition, the affected banks would initially be given a deadline to bring their capital reserves up to the required level on their own. "Compulsory capitalization is definitely a controversial issue," says Michael Meister, deputy leader of the conservatives' parliamentary group in the Bundestag.

It is still unclear whether the plan would receive majority support in Germany and the EU. France is pushing for the expanded European Financial Stability Facility (EFSF) bailout fund to quickly and unbureaucratically aid embattled banks with sorely-needed capital. This would be a less conspicuous way of recapitalizing French banks -- and at a lower cost to the French.

'The Faster, the Better'

By contrast, the German government wants to limit EFSF operations to extreme emergencies. The Germans say that initially, at least, the struggling banks would have to attempt to raise fresh capital from private investors. If that doesn't succeed, says Berlin, then the home country will have to step in.

France is, however, not alone in its demand that the bailout fund be used to recapitalize banks. Support for the idea also comes from countries that generally argue for cautious spending of taxpayers' money. Austria, for instance, whose banks are also under threat, does not oppose in principle using the EFSF to support the sector.

Another contentious aspect is Germany's determination to give the Bundestag a say on how the money is spent. The plan calls for the majority of EFSF operations to be subject to the approval of a parliamentary committee. Germany's partners in the EU have expressed reservations about this approach. "A government needs the general confidence of parliament for it to be able to act effectively on decisions that affect the financial markets," says Luxembourg Finance Minister Luc Frieden, "and this is especially true of large countries."

A very different proposal to use the new bailout funds more efficiently has been made by Walther Otremba, a former top official in the German Economics Ministry. In an article in this week's SPIEGEL, the former state secretary proposes creating a Europe-wide insurance for struggling peripheral countries like Portugal, Italy, Spain and Ireland. According to Otremba, the concept would be financed from the risk premiums of the associated bonds -- and would provide a way of preventing the contagion from spreading to other members of the euro zone should Greece default.

Speaking in Berlin last Thursday, ECB President Jean-Claude Trichet made it clear that he thought domestic programs should be used first to strengthen the banks' equity capital base. He added that the EFSF bailout fund would soon be in a position to lend money to the member states to recapitalize their banks. "The faster the EFSF can tackle the root causes of the crisis," Trichet said, "the better."

Translated from the German by Paul Cohen

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