BRUSSELS, Belgium — European governments will force their largest banks to quickly and significantly increase their cushions of capital in order to ride out market turmoil brought on by the debt crisis, officials announced Wednesday.
By the end of June, the banks will need to have a 9 per cent core tier 1 capital ratio — which measures how much good capital a bank holds compared with its risky investments.
The bank recapitalization is an important first step in the grand plan Europe needs to pull the continent back from the brink and prevent another global recession.
With an agreement in place on insulating the banks from turmoil, the leaders can now move on to the sticky question of how big banks’ losses on Greek bonds should be — so the country has a fighting chance of digging out from under its debt burden — and how to ensure that the crisis doesn’t swallow any more countries.
The requirement announced Wednesday evening after a meeting of the leaders of the European Union’s 27 countries represents a significant increase over this summer’s stress tests, which passed banks that had a ratio of 5 per cent.
The new rules will even require banks to fully account for all sovereign debt they hold. The banks’ capital levels will be calculated only after banks mark down the government bonds they held as of Sept. 30 to a value closer to the market price. That presumably is to dissuade banks from suddenly dumping the bonds.
In the July tests, they had been allowed to assume that at least some government debt would be paid in full.
That will clearly not be the case, with leaders working on a plan to ask banks to lose as much as 60 per cent of their investment in Greek bonds, much more than they had previously agreed to take.
Losses on Greek debt and the market turmoil caused by the crisis more generally prompted European leaders to ask banks to shore up their balance sheets.
The rules mean that large European banks will satisfy international banking guidelines known as Basel III years ahead of the 2019 schedule.
Polish Finance Minister Jacek Rostowski, who announced the decision after a summit in Brussels, said banking regulators would later announce how much banks will have to raise to meet the new rules since it’s still unclear how much their losses on Greek debt will be.
European officials had earlier said the new rules would force banks to raise just over C100 billion ($140 billion).
Rostowski said the more stringent ratio would be temporary — banks would only have to prove once that they met the standard. That’s an indication that the leaders hope the rest of their package will make such safeguards unnecessary in the future.