The euro crisis: Is everything fixed?

Economist
December 16, 2011

At the European Central Bank's last meeting, Mario Draghi did not announce any plans to scale up purchases of sovereign debt and, indeed, he indicated that previous statements interpreted as a promise to do so were in fact no such thing. He did, on the other hand, announce new measures to boost liquidity across euro-zone banking systems, including a facility through which banks can borrow unlimited amounts from the ECB, very cheaply, for up to three years. It quickly dawned on observers that banks might just use this borrowing to fund purchases of government debt, thereby addressing the crunch in sovereign debt markets. And I see that some writers are now arguing that this step actually amounts to the critical turning point in the crisis. Is it?

The wheeze, however, seems to have been too clever by half. Hours after Mr Sarkozy was urging banks to bail out governments, the European Banking Authority (EBA) released the results of its updated stress tests showing that European banks need to raise €115 billion ($149 billion) in extra capital, mainly to offset a fall in the value of their existing holdings of government bonds issued by troubled peripheral European countries.

The banks with the biggest capital shortfalls are those from Spain, Greece and Italy. Several may have to tap government bail-out funds to raise the capital, creating the circular prospect of governments bailing out their banks that are in turn supposed to bail out the government. Italian banks, for instance, will need €15 billion in additional capital; among them is UniCredit, Italy’s biggest bank by assets, which holds some €40 billion in Italian government debt and needs to raise almost €8 billion in capital. Spanish banks need €26 billion. Europe’s core has not been spared either. Banks in Germany, the euro area’s biggest creditor country, need additional capital and Commerzbank, Germany’s second-largest bank, may also find itself asking for government help to fill a €5.3 billion hole in its balance-sheet.

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