Bankers Balk at EU Push for Bigger Greek Losses

By Aaron Kirchfeld - Oct 17, 2011 9:55 PM GMT+0700

Josef Ackermann, the head of Deutsche Bank AG (DBK) and chief lobbyist for the world’s largest financial firms, has pressed European leaders for months to devise a strategy to stamp out the sovereign debt crisis.

Now that European Union officials are moving toward an agreement that may include bigger losses on Greek debt holdings and the forced recapitalization of lenders, the Deutsche Bank chief executive officer and Washington-based Institute of International Finance he chairs are pushing back. He travels to Brussels this week for talks with policy makers.

Forcing lenders to boost capital would be counterproductive, and getting investors to accept larger losses on Greek holdings difficult, Ackermann said on Oct. 13. Opposition from banks may hamper efforts by German Chancellor Angela Merkel and French President Nicolas Sarkozy to present a breakthrough at an Oct. 23 summit of euro leaders in combating the crisis, which has driven Greece toward default, roiled global markets and dented confidence in the survival of the 17- nation currency.

“What’s most depressing about this whole thing is the squabbling between politicians, regulators and banks,” said Christopher Wheeler, a London-based analyst with Mediobanca SpA. “Banks have to take positive action alongside the EU to find a solution, which is a combination of dealing with sovereigns as well as capital concerns.”

Revamped Strategy

Reaching a compromise is in the interest of banks, whose earnings have been battered by financial-market turbulence, Wheeler said. Frankfurt-based Deutsche Bank scrapped its profit forecast on Oct. 4 and announced 500 job cuts and further writedowns of Greek bond holdings amid what the company described as a “significant and unabated slowdown in client activity” brought on by the debt crisis.

Germany dampened optimism for a complete fix to the crisis at the Oct. 23 meeting. Merkel has made it clear that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled,” Steffen Seibert, Merkel’s chief spokesman, said at a briefing in Berlin today.

European financial companies dropped for a third day. The Bloomberg Europe Banks and Financial Services Index of 46 stocks fell 2.5 percent, led by Dexia SA (DEXB) and Commerzbank AG (CBK), by 4:50 p.m. Central European Time.

Bigger Losses

Europe’s revamped strategy to beat its two-year sovereign debt crisis won the backing of global finance chiefs in Paris this past weekend. In the works is a five-point plan foreseeing a solution for Greece, bolstering of the firepower of the 440 billion-euro ($611 billion) European Financial Stability Facility bailout fund, fresh capital for banks, a new push to boost competitiveness and consideration of European treaty amendments to tighten economic management.

The Greek bond losses now envisaged in the plan may be accompanied by a pledge to rule out debt restructurings in other countries that received bailouts, such as Portugal, to persuade investors that Europe has mastered the crisis, people familiar with the discussion said on Oct. 14.

Options include altering a July accord struck with investors and spearheaded by Ackermann for a 21 percent net- present-value reduction in Greek debt holdings. One variant would take that loss up to 50 percent, the people said.

‘Political Reality’

German Finance Minister Wolfgang Schaeuble said yesterday the reduction of Greece’s debt by means of private-investor participation must be bigger than agreed to in July by euro- region leaders to achieve a “sustainable solution” for the country. There will be negotiations with banks about a debt cut for Greece, Schaeuble said on ARD public television, according to a transcript of the interview.

Policy makers’ priority needs to be convincing investors that Italy, the third-largest issuer of debt after the U.S. and Japan, is a risk-free investment, said Holger Schmieding, a London-based chief economist for Berenberg Bank. Still, increasing private contributions to a Greek rescue would help mollify German voters and injecting capital into banks may ease investors’ concerns about the stability of the financial system, he said.

“Being a realist, I don’t see the chance of avoiding larger private-sector involvement, especially given the German political reality,” said Schmieding. “We also probably need some type of recap after raising market expectations over the last few weeks. But the ultimate thing is impressing on the market that Italy is safe.”

No ‘Compelling Case’

The Institute of International Finance on Oct. 10 rejected pressure for banks to accept larger losses on their holdings of Greek government debt. There are no plans to change the deal, Hung Tran, deputy managing director of the IIF, said in a telephone interview.

“The potential risk and potential costs of revisiting the deal far outweigh any potential benefits,” Tran said. “July 21 represented a balanced approach with significant concessions from private investors. We should remind the public sector that we need to preserve the voluntary nature of the Private Sector Agreement, and therefore honor and implement the deal.”

Charles Dallara, managing director of the IIF, which represents more than 450 financial institutions globally, told the Financial Times on Oct. 14 that he didn’t see a “compelling case” to reopen negotiations.

One risk to changing the agreement is that forcing bigger writedowns could be viewed as a default, triggering insurance bought against such an event, known as credit default swaps, and risking contagion to larger countries such as Italy and Spain, according to analysts.

Rescue Fund

Greece, Italy, Ireland, Portugal and Spain, known as the GIIPS, have about 2.9 trillion euros of government bonds outstanding, according to data compiled by Bloomberg. Italy accounts for more than half, or 1.59 trillion euros, the data show.

About 413 billion euros of GIIPS debt is held by 38 of Europe’s largest lenders, according to an analysis of European stress-test results by Alberto Gallo, a strategist at Royal Bank of Scotland Group Plc (RBS) in London. Those holdings equal almost 40 percent of the banks’ 1.1 trillion euros of equity, according to Gallo.

To combat concern about contagion, officials are considering ways of multiplying the strength of Europe’s temporary rescue fund. The likeliest option is using it to partly insure new bonds issued by distressed governments. EFSF guarantees of new bonds might range from 20 percent to 30 percent, a person familiar with those deliberations said.

More Capital

There are risks to this plan, Joachim Fels and Sung Woen Kang, analysts at Morgan Stanley, said yesterday in a research note.

“Guaranteeing first losses may well turn out less appealing to investors than many hope and a larger private sector involvement could spark another wave of contagion,” the analysts wrote. “Banks would probably choose to shed assets and de-lever rather than raise capital in the market if they are given a longish grace period before having to accept recapitalization through their sovereign and the EFSF.”

All lenders judged by the region’s top banking regulator to be systemically important should be required to hold “temporarily higher” amounts of capital, European Commission President Jose Barroso said on Oct. 12. The European Banking Authority discussed making the banks hold core capital equal to at least 9 percent of their assets, up from a 5 percent core Tier 1 capital requirement imposed in the stress tests carried out by the regulator earlier this year, according to a person familiar with the proposals.

‘Held Hostage’

Those new criteria would lead to a 220 billion-euro capital shortfall at 66 of the participating banks, with the biggest gaps at Edinburgh-based RBS, Deutsche Bank and Paris-based BNP Paribas (BNP) SA, according to a note published by Credit Suisse Group AG analysts on Oct. 13.

The European Banking Federation, in a statement on Oct. 13 titled “High time for coordinated European solution on sovereign debt,” said recapitalization is not “central to the solution” and the region’s lenders have continued to place trust in sovereign debt and made credit available to national governments throughout the crisis.

“European banks feel they are being held hostage by the sovereign debt crisis,” said Guido Ravoet, secretary general of Brussels-based EBF, which represents more than 5,000 banks. The region’s lenders have already “substantially increased” their capital and among about 90 lenders that took part in July’s stress tests, the average core tier 1 capital ratio, a measure of financial strength, was 8.9 percent at the end of 2010, the EBF said.

Ackermann, Merkel

Bankers including Ackermann have also said that tougher regulation, higher capital requirements and bigger sovereign debt writedowns may force them to restrict lending, which could hurt economic growth.

Deutsche Bank, which navigated the financial crisis in 2008 without a government capital injection, will “do everything” not to take money from the state as part of assistance efforts for European banks, Ackermann said in a speech last week, when he criticized the EU’s plans.

His remarks created a stir in Germany. Newsmagazine Spiegel carried the headline “Everyone against Ackermann,” while the country’s biggest tabloid, Bild-Zeitung, wrote: “New Ice Age between Merkel and Ackermann.”

Even if Deutsche Bank didn’t need direct state support in the last financial crisis, “it profited from the fact that the government staved off a collapse of the financial market,” Social Democrat Carsten Schneider told Der Spiegel. “A little bit of humility wouldn’t hurt.”