Proposed Capital Increases Could Force European Banks to Reduce Assets by €1.8 Trillion

If the European banks are required to increase their capital ratio by 1%, then they could be forced to reduce risk weighted assets (RWAs) by €1.8 trillion to achieve the ratio, according to PricewaterhouseCoopers (PwC) experts, commenting ahead of the G20 meeting on the eurozone deal.

Richard Barfield, director at PwC, said: “In order to hit the higher capital ratios banks will be faced with two choices – increase capital or reduce assets. The latter course could be economically damaging as it will increase the price or reduce the availability of lending, or both, which will have a negative impact on the growth agenda. If the European banks are required to increase their capital ratio by 1% and are unable to raise the capital to do this, they would be forced to reduce RWAs by €1.8 trillion to achieve the ratio.”

This is based on the fact that as at 31 December 2010 a 1% increase in core Tier 1 capital for the European banks would be equivalent to either:

  • Core tier one capital of €112bn for Euro banks on a Basel II basis.
  • A reduction of €1.3 trillion of RWAs (roughly €2.6 trillion in lending).

On a Basel III basis, these figures increase by roughly 40% to €157bn or RWA of €1.8 trillion.

Barfield continued: “The key issue in the eurozone at the moment is liquidity, not capital. The crisis conditions mean that G20 unity will be important. What the markets and banks are desperately seeking is greater certainty. Until Greece is resolved, the medium-term funding markets for banks are likely to remain frozen. It remains to be seen whether the time has come to create a capital amnesty to allow banks to negotiate the current troubled waters without unwanted deleveraging.

“The G20 is likely to endorse additional capital for globally systemically important financial institutions and is focusing on additional capital buffers for the larger banks – additions to the numerator in the all-important capital ratio calculation. To date, there has been little focus on RWAs. We expect that RWA calculations under Basel II are likely to become an increasing area of focus for banking regulators,” he added.

Yael Selfin, head of PwC macro consulting, commented on the eurozone deal and its continued relevance to the G20 talks: “The threat of acute recession in the eurozone triggered by a continued crisis in sovereign debt markets and worsening banks’ balance sheets is a reality that will reach as far as the G20 economies and beyond. The eurozone crisis is likely to be top of the agenda as the crisis there now looks to have gone beyond what eurozone leaders are themselves able to solve. The pressure is on President Sarkozy, as G20 chair, to persuade the Chinese and other countries to contribute to Europe’s bailout fund and to get agreement from all G20 members to extend the IMF’s fire power – only a year after they last agreed to an increase. The G20 needs to show decisive action to prevent a downward spiral in the global economy taking hold.”


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