Deleveraging in the Eurozone

by Stephen Kinsella and Vincent O'Sullivan

Vox
December 17, 2011

The capital shortfall at EU banks is 8% higher than originally thought, according to the latest assessment from the European Banking Authority. This column examines the evolution of loan-to-deposit ratios in big European banks. It says banks have been buying back their debt securities, hoarding profits, limiting bonuses, and deleveraging. However, write-downs of sovereign debt have largely offset these efforts.

The capital shortfall at EU banks is 8% higher than originally thought, according to the latest assessment from the European Banking Authority (EBA 2011) released on 8 December. In the aggregate, European banks need to raise €114.7 billion as an exceptional, temporary capital buffer against sovereign debt exposures and to ensure their individual Core Tier 1 capital ratio reaches 9% of risk-weighted assets by the end of June 2012.

The EBA tests indicate that approximately one-third of banks sampled need stronger capital reserves to meet the June 2012 deadline. In particular, the EBA finds that banks in Italy and Spain will need to raise significantly more capital, while French banks have already built up sufficient reserves to buffer against potential sovereign bond write-downs. German banks have a capital shortfall of €13.1 billion, which is three times the amount originally estimated in October, although this is still small relative to the size of its banking system. In contrast, banks in Ireland, Luxembourg, Sweden, the UK, and six other countries require no additional capital.

Some investors may be relieved that the overall recapitalisation figure is not higher in light of growing concerns over the Eurozone, but others may be surprised that the gap has not been reduced already. In the last two months, banks have taken a number of important steps to bridge their capital shortfall, such as buying back their debt securities, hoarding profits, limiting bonuses and dividend payments, converting some debt to equity-like instruments, and, of course, deleveraging. However, write-downs of sovereign debt have largely offset those efforts.

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