How much capital do European banks need? Some estimates

by Viral Acharya, Dirk Schoenmaker and Sascha Steffen

Vox
November 22, 2011

The lack of market confidence in European banks is fed by the uncertainty about Eurozone sovereign debt. This column argues governments and banking supervisors should agree a recapitalisation package well before Christmas. It adds that the required amount to be raised by each bank should be presented as a euro amount and not as a ratio so as not to tempt banks to cut down assets instead of raising capital.

The European banking system is freezing up. Several banks are not able to fund themselves in the market. The lack of market confidence in European banks is fed by the ongoing uncertainty about Eurozone sovereign debt (as well as real estate) to which these banks are exposed.

At the recent October Summit, European leaders agreed on a recapitalisation package for European banks. Unfortunately, they specified required capital as a ratio (capital divided by risk-weighted assets) instead of a euro amount. As a result banks are now deleveraging instead of seeking fresh capital. A credit crunch is currently on its way. Moreover, the required recapitalisation falls short at what is needed to restore confidence.

We cannot afford a banking crisis with a detrimental impact on bank lending (real economy) and public finances (further rescues). A strong recapitalisation of the European banking system is crucial; the earlier October recapitalisation has not been decisive. Dealing with the banking system problems is a necessary condition for fostering European growth, but not a sufficient condition as the sovereign-debt problems also need to be addressed.

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