European bankers and politicians leapt to defend the region's banks on Thursday, rejecting an International Monetary Fund (IMF) estimate that they need 200 billion euros ($290 billion) in new capital to reflect sovereign debt losses.
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IMF chief Christine Lagarde's call on Saturday for mandatory capitalization of European banks to prevent a world recession has reignited a debate over whether they have raised sufficient capital to withstand a severe downturn.
The clash highlights diverging views about the underlying safety of the European banking system. The IMF and the International Accounting Standards Board (IASB) have both voiced concerns, while European regulators, politicians and banking associations argue that banks have a sufficient capital cushion to cope with market turbulence and worries over sovereign debt after several rounds of capital raising across the continent.
A European source told Reuters on Wednesday that the IMF had estimated European banks could face a capital shortfall of 200 billion euros, a figure rejected by European bankers and policymakers.
The IMF figure is much higher than estimates of banks' capital needs following stress tests in July.
J.P Morgan has estimated that based on the stress-test data, European banks showed a capital deficit of 80 billion euros, with UK banks needing 25 billion euros, French banks 20 billion euros and German lenders 14 billion euros.
The European Commission reiterated it saw no need for drastic action since the publication of the stress test results, echoing comments made by the European Banking Authority on Tuesday.
"Our analysis of the situation hasn't changed, it is in fact shared by the member states. We did have an in-depth discussion when the results of the stress tests for banks were presented and this our diagnosis and there is no reason to change it now," Commission spokesman Amadeu Altafaj told a regular briefing.
The bank stress tests did not factor in the impact of a significant drop in the value of sovereign debt.
A Euro zone official who declined to be named said "We are aware of those (IMF) numbers, but we think there are serious methodological flaws in that paper and discussions are going on with the IMF about them."
Eurozone governments and the European Central Bank disagree with the "very questionable" methodology of the IMF estimates on bank capital requirements, another European government official said. The European Central Bank declined to comment.
The view was echoed by the German Banking Association BdB which represents lenders such as Deutsche Bank and Commerzbank, and the VOEB, which represents troubled lenders such as WestLB. Both insisted there was no immediate need to inject capital into German banks.
"We do not understand how the IMF has come to this conclusion. Earnings statements do not back the conclusion of such a situation among German banks," the German VOEB said.
France took a similar line on its banks, whose shares came under intense pressure during August amid concerns over access to funding, with French Budget Minister Valerie Pecresse saying they were not a cause for concern.
"French banks are now better capitalized than a year ago; they passed stress tests which were extremely tough less than a month ago. I don't think there is any cause for worry over French banks," she said at an event on Thursday.
European bank shares traded slightly lower by 1043 GMT, with the STOXX 600 European banking index down 0.4 %. Meanwhile, key euro-priced bank-to-bank lending rates edged higher, driven by concerns about the outlook for the economy and euro zone banks.
The fight over whether European banks have sufficient capital highlights a flaw in the accounting treatment of sovereign debt, experts say.
"One enormous weakness is that European banks are encouraged to load up on sovereign debt without pricing in the appropriate risk penalty," said Roger Myerson, winner of the Nobel memorial prize in economics in 2007. "It creates the wrong incentives for governments and banks."
Myerson, who was recognized for his contributions to mechanism design theory, said that under Basel accounting rules, sovereign debt is still given a risk weighting of zero.
This encourages banks to buy risky debt without having to build an appropriate capital cushion, and provides an incentive for governments not to address their deficit levels since they are still able to issue debt.
"This looks like the entire problem of the euro zone," Myerson told Reuters.
At the low end this corresponded to the so-called "haircut" on banks' share of a planned second bailout of Greece now being finalized. A 50% loss represented the discount markets were expecting at the end of June.
Eight European banks failed the EU stress test in July, and the total new capital they needed to remedy the situation was 2.5 billion euros ($3.6 billion), less than had been expected before the tests.
($1 = 0.695 Euros)