Christine Lagarde, the head of the International Monetary Fund (IMF), has called for European banks to be forced to raise more cash as the world economy enters a “dangerous new phase” which could end in recession.
Christine Lagarde called for “substantial” and mandatory recapitalisation to bolster European banks’ balance sheets. Photo: AP
Sarah Rainey and Rowena Mason
the Telegraph, UK
9:30PM BST 27 Aug 2011
In a remarkably gloomy assessment of the world economy, Ms Lagarde warned that urgent action is required to stave off the threat of global recession and another credit crisis.
Sounding a stark warning to stronger European countries such as Britain and Germany, the new IMF chief said: “We could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis.”
To reduce these risks, she called for “substantial” and mandatory recapitalisation to bolster European banks’ balance sheets, which will be “key to cutting the chains of contagion”.
Ms Lagarde, who was speaking at the US Federal Reserve’s annual forum at Jackson Hole, said the recapitalisation should first be financed through private channels, but could also be sourced from a Europe-wide bail-out fund.
“Developments this summer have indicated we are in a dangerous new phase. The stakes are clear. We risk seeing the fragile recovery derailed. So we must act now,” she said.
Ms Lagarde’s comments risk creating new panic about the funding levels and financial stability of European banks.
There have been concerns that lending between banks has started drying up over recent weeks, which was a key sign of the “credit crisis” in 2008.
Analysts from Royal Bank of Scotland have already warned that “European banks’ short-term wholesale funding markets continue to send growing signs of stress” and “the intense level of financial system interconnectedness means this is… negative for all European banks’ equity values”.
Rumours have swept the markets in recent weeks, causing a number of high-profile banks to deny that they have liquidity problems.
The French bank Societe Generale was forced to issue a statement saying “all market rumours” were untrue, after it led a pack of French banks with plunging share prices.
However, despite Ms Lagarde’s concerns, only nine banks failed the European Banking Authority’s (EBA) stress tests in July, which meant they only had to raise €2.5bn (£2.2bn) in total.
Britain and France’s lenders received a clean bill of health, but five banks in Spain, two in Greece and one in Austria failed the tests.
Another German bank would have failed, but dropped out of the tests due to a dispute over its capital. A further seven Spanish, two Greek, two Portuguese and two German lenders were among the 16 identified as perilously close to danger.
The EBA was, however, strongly criticised by analysts and investors, who said it had failed to capture the severity of the current sovereign debt crisis sweeping across the eurozone.
Experts said criteria used for the stress tests were overly optimistic. Using tougher measures, Credit Suisse analysts said at least 14 banks should have failed the test. The analysts estimated that these banks, which would include all seven Greek banks participating in the process, need to raise about €45bn in new capital.
Andrea Enria, chairman of the EBA, insisted the tests the organisation had performed were rigorous, though he admitted market conditions had worsened since the criteria were set.
The tests were conducted on banks in 21 countries to assess their ability to withstand a prolonged recession without suffering such deep losses that their core capital ratios – their reserves against losses – dropped below 5pc.
Tonight, sources said two of the biggest Greek banks – Alpha Bank and Eurobank EFG – were on the brink of a €2bn merger, in which they have negotiated a €500m capital injection from the Qatar Investment Authority.
- Lagarde Urges ‘Mandatory’ Recapitalization of European Banks (businessweek.com)
- Lagarde says recovery ‘fragile’ (bbc.co.uk)
- Eurobank, Alpha Said to Plan Merger Forming Biggest Greek Bank (businessweek.com)
- IMF’s Lagarde Warns World Economy Entering ‘Dangerous’ Phase (businessweek.com)