G-20 Seeks Broader Solution for Europe Debt Crisis

http://www.nytimes.com/2011/10/15/business/global/g20-seeks-broadersolution-for-europes-debt-crisis.html
PARIS Even as officials of the Group of 20 industrialized nations were gathering here on Friday to flesh out a solution to the European debt crisis, a new challenge confronted them, when ratings agencies warned that globally interconnected banks in France and elsewhere faced rising risks. After offering piecemeal solutions for more than a year, the G-20 finance ministers are seeking a broader plan to prevent the crisis from engulfing big countries like Italy or Spain, whose sovereign credit rating was cut anew on Thursday, a move that may deepen the impact of the debt crisis on European banks. The United States Treasury secretary, Timothy Geithner, who is attending the meetings, has said a solution is needed to prevent Europes troubles from infecting the rest of the world. Franois Baroin, the French finance minister, said after talks on Friday that officials had already come to some agreements that will be very important, but he did not elaborate. The weekend discussions are a precursor to a summit meeting of European leaders planned for Oct. 23 in Brussels. Officials want to strike a deal soon to increase the size of a bailout fund for troubled countries and banks across the Continent, known as the European Financial Stability Facility. They also want to force Europes banks to raise more capital and to require private investors to take larger-than-anticipated losses on their holdings of Greek government bonds to avoid running up the bill to taxpayers. Financial markets seemed to believe that the Europeans were getting serious about a solution: stock markets have risen recently on hopes for a deal, especially after Chancellor Angela Merkel of Germany and the French president, Nicolas Sarkozy, pledged last weekend to deliver a plan. Major European stock indexes and Wall Street all rose this week.

But investors reading between the lines see further complications, especially for Europes banks. On Friday, Standard & Poors downgraded the credit rating of the biggest French bank, BNP Paribas, citing its material exposure to Italy, which faces problems similar to Greeces, but on a much larger scale. Also Friday, the Fitch ratings agency said it would review various ratings for Deutsche Bank, BNP Paribas, Socit Gnrale, Credit Suisse and Barclays, citing increased challenges the financial markets are facing as a result of economic developments and regulatory changes. That followed the announcement by S.& P. that it was downgrading Spains sovereign rating again, to AA- from AA, amid signs that harsh austerity measures may tip the country into a recession. The decision is ill timed for the many European banks that together hold about $637 billion worth of Spanish government debt. The banking industry has been girding for battle with European policy makers and regulators in the coming days, especially over a plan that would force the banks to take losses on their holdings of Greek debt of up to 60 percent much more than a 21 percent loss agreed to under an accord reached by European leaders in July as part of a second Greek bailout. Several of Europes biggest banks, including BNP Paribas and Socit Gnrale, have said they are ready to take losses of around 50 percent. But most banks that hold Greek debt would have to sign off on a new deal, and an agreement is not certain. Bankers are particularly angered by two additional proposals from the European Banking Authority, which has come under fire for overseeing flimsy tests on the safety margins of Europes banks. One would require lenders to raise their capital buffers to around 9 percent, from 6 percent now, or be forced into the undesirable position of taking money from their governments. Another would require lenders to value all their sovereign debt holdings at current market prices, as part of a stress test to ensure that Europes banks have enough capital to insure against large-scale losses if the crisis were to spread. Goldman Sachs on Friday said at least 50 of the 91 European banks tested previously by the banking authority were likely to fail the revised stress tests, and would need to raise

as much as 298 billion euros if the capital requirement were raised to as high as 9 percent. While European banks hold about $128 billion in Greek sovereign debt, that is dwarfed by the whopping $819 billion they hold in Italian debt, according to the most recent data from the Bank for International Settlements, published in March. All told, European banks hold $2.165 trillion worth of sovereign debt from Portugal, Italy, Ireland, Greece and Spain, according to the Bank for International Settlements. Banks say that new capital requirements will force them to curb lending to consumers and businesses, hurting economic growth. But some are already selling assets and businesses to raise money to meet them. Charles H. Dallara, the managing director of the Institute for International Finance, a powerful lobbying group of the worlds biggest financial firms, said the banking authoritys plan also would create an uneven playing field globally for European banks. Requiring banks to value their Italian and other sovereign debt holdings at current prices, known as marking the assets to market, would also create serious risks, Mr. Dallara said in an interview. The plan would put further pressure on the debt markets of those countries, and potentially eat up any new capital which may be raised by those banks or injected by governments. The risk, he added, is that a vicious circle is created where capital goes through the front door and comes out the back door, as the value of sovereign debt remaining on banks balance sheets declines. In a sign of nervousness about the rising costs of the crisis, the difference between the interest rate that France pays to borrow in international markets, compared with that paid by Germany, rose on Friday to the highest level since the euro currency was created in 1999. France, which is leading the euro zone rescue talks together with Germany, is particularly wary of feeding money into major French banks because President Sarkozy does not want to risk damaging Frances AAA credit rating, which came under scrutiny after S.& P. downgraded the United States in August. If France were to pump too much money into its banks, that would jeopardize its efforts to reduce the deficit and debt level, putting the rating at risk.

Should that happen and France get sucked into Europes debt crisis, that would threaten one of the two main pillars along with Germany supporting the euro, taking the crisis to a new level. By LIZ ALDERMAN Published: October 14, 2011