Analysis: Euro zone likely to backstop banks with promises rather than cash

Wed Dec 4, 2013 10:47am EST
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By Jan Strupczewski

BRUSSELS (Reuters) - Euro zone governments have set aside almost no money to make good on their promise to recapitalize ailing banks after a health check next year.

A Reuters survey of euro zone backstops showed very few governments have any money earmarked for such a purpose. If called upon, they would have to prop up their lenders with bonds or guarantees rather than cash.

While acceptable from a regulatory point of view, that would only strengthen the "doom loop" which has marked the euro zone debt crisis and describes a downward spiral where cash-strapped sovereigns have bailed out weak banks, which were in turn chock full of that government's bonds as they fell in value.

Next year, the European Central Bank will check what assets euro zone banks have now and the European Banking Authority watchdog will test how the value of those assets changes under an adverse economic scenario in what is called a stress test.

The main purpose of the tests is to show investors that the euro zone banking sector is healthy in an attempt to restore normal lending to the economy, boosting economic growth.

But doubts as to the soundness of the banking system may linger because in some cases it is likely to increase the interdependence of banks and sovereigns rather than end it.

Banks found short of capital will have to raise it privately. If they fail to do so, the government may eventually have to step in with funds.

In the health checks next year, government bonds will be treated as risk free. But this means that in another sovereign debt crisis the value of the bonds received as capital could fall dramatically.   Continued...

The euro sculpture is seen outside the head quarters of the European Central Bank (ECB) in Frankfurt, November 5, 2013. REUTERS/Kai Pfaffenbach