European Rescue Plan Takes Shape

By Simon Kennedy and Victoria Ruan - Oct 14, 2011 9:32 PM GMT+0700

European officials are outlining a rescue plan that may include deeper investor losses on Greek bonds, higher bank capital levels and increased firepower for bailouts and the International Monetary Fund.

The plan’s elements emerged as finance ministers and central bankers from the Group of 20 began talks in Paris lobbying their European counterparts to end the two-year sovereign debt crisis. Underscoring the need for action, Standard & Poor’s yesterday cut Spain’s credit rating for the third time in three years and new data showed the eight largest U.S. money-market funds almost halved their lending to French banks last month.

“The sense of urgency is here,” Eric Chaney, chief economist for AXA SA (CS), Europe’s second-largest insurer, said in a Bloomberg Television interview with Maryam Nemazee in Paris today. “There will be a lot of pressure on Europeans to find a solution.”

European leaders may complete the plan at an Oct. 23 summit to present to a gathering of G-20 chiefs Nov. 3-4. The aim is to craft what French Finance Minister Francois Baroin today called a “durable, complete package” to fix the turmoil that has propelled Greece to the edge of default and is rattling global markets. Europe’s Stoxx 600 headed for a third week of gains amid optimism policy makers will contain woes.

Geithner’s View

“Europe is clearly moving,” U.S. Treasury Secretary Timothy F. Geithner said in an interview today with CNBC in Paris. “If you look at what they’ve been saying, they are talking about a much more comprehensive package of measures.”

Australian Treasurer Wayne Swan told reporters that “the first priority” for the Group of 20 “is for Europe to put their own house in order.”

Three months after banks and insurers agreed to a voluntary loss of about 21 percent on their Greek debt, they are being pushed to accept a larger so-called haircut as Greece’s economy deteriorates. German banks are preparing for losses of as much as 60 percent, said three people with knowledge of the matter.

“A Greek debt writedown, even if it takes place, should only be ventured after careful and conscientious preparation in order to prevent anything worse from happening and to pave the way for structural reforms,” German Chancellor Angela Merkel said in a speech in Karlsruhe, southwest Germany, today.

Greek Strikes

In Greece, a wave of strikes and walkouts protesting budget cuts sparked criticism from Finance Minister Evangelos Venizelos today. “The picture we have seen over recent days is one of lawlessness,” he told lawmakers. “Some believe that occupations, strikes, blackmail, pressure can lead to the satisfaction of vested interests to the detriment of the national interest.”

Concerned that banks lack the capital to absorb a shock in sovereign debt, European authorities are working on a plan that may force financial institutions to raise at least 100 billion euros ($138 billion) in additional capital, according to analysts’ estimates. That money would come either from existing investors -- who are signaling they may resist providing it --or state funding that may come with strings attached.

The European Banking Authority intends to complete an assessment of the region’s capital needs before a meeting of European Union finance ministers to precede the summit, said Jonathan Todd, a spokesman for the European Commission.

Capital Buffer

Banks may be required to maintain a 9 percent capital buffer to absorb sovereign risks, up from the 5 percent core capital level used in July’s stress tests, a person with knowledge of discussions at the authority, the EU’s top banking regulator said this week.

French Finance Minister Francois Baroin said on Europe 1 radio today that 9 percent may be a “good” level.

The 46-member Bloomberg Europe 500 Banks and Financial Services Index has dropped just under a third this year, paced by Dexia SA, the Franco-Belgian lender that’s being broken up. Today, the Stoxx 600 and the gauge of banks added 1 percent.

In one boost for Europe’s crisis-fighting abilities, Slovakian lawmakers yesterday approved a revamping of the region’s rescue fund, completing ratification across the 17 euro countries.

The European Financial Stability Facility will now have a war chest of 440 billion euros, be allowed to buy the debt of stressed euro-area nations, aid troubled banks and offer credit line to governments. Its original role was to sell bonds to finance rescue loans.

Spending Power

Its new spending power may still not be enough to contain the crisis, with Royal Bank of Scotland Group Plc economists saying a 2 trillion-euro capacity is required to persuade investors that Spain and Italy are safe. As taxpayers chafe at providing even more cash and AAA-rated governments worry about their own standing, policy makers are now looking to leverage the fund, perhaps by insuring a portion of new bonds issued by debt-ridden nations.

French 10-year government bonds fell today, increasing the extra yield investors demand to hold the securities instead of German bunds to as much as 91.3 basis points. That’s the most since the euro started in 1999.

European officials are working out how to scale up the financial clout without requiring another round of parliamentary approvals or tapping the European Central Bank’s balance sheet. That may involve providing a partial guarantee to new bond sales, a step endorsed by the ECB.

Permanent Fund

There may also be a consensus in the euro area to set up the permanent rescue fund, the 500 billion-euro European Stability Mechanism, by mid-2012, a year earlier than planned.

“The resources available in the IMF and the EFSF are not adequate,” South African Finance Minister Pravin Gordhan said in Paris. He said emerging market powers have indicated a readiness to offer more support for international institutions.

Countries from China to Brazil are considering increasing IMF lending resources to help stem Europe’s travails, G-20 and IMF officials said. Talks are still in the preliminary stages as potential contributors wait to see what fixes Europe delivers first. Managing Director Christine Lagarde said last month that her current $390 billion cash pile may not be large enough to meet all loan requests should the global economy worsen.

“Emerging markets, in particular China, may feel the pressure at this point to make some gestures to help the West,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. “They do not want to invest too much given that the West’s problems are of its own making, and if they help, they want to do so in a way that brings them benefits and recognition.”

The G-20 meetings in Paris conclude tomorrow with a press conference scheduled for 4:15 p.m. Ministers meet for dinner tonight at about 7 p.m.

To contact the reporters on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net; Victoria Ruan in Beijing at vruan1@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net