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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.
"In economic terms, it is not good enough. It actually strengthens the loop between banks and sovereigns," said Carsten Brzeski, economist at ING bank.
"If the way to recapitalize a bank by the sovereign is through handing out bonds, it is strengthening rather than weakening the vicious circle," he said.
Ratings agency Standard & Poor's estimated this month that the euro zone banking sector's capital shortfall may total slightly more than 1 percent of the bloc's economic output which would add up to 95 billion euros.
Banks in Spain have been recapitalized with bonds, but they received the paper of the euro zone bailout fund ESM, which has top credit ratings.
Italian bank Monte dei Paschi di Siena (BMPS.MI), however, has taken 4.1 billion euros in government aid through bonds underwritten by the state, which has a BBB rating from S&P.
Should investors ever decide they do not trust the highly indebted Italian government to pay them back, the value of any Italian bonds serving as a bank's capital would fall dramatically. Italy's public debt is to rise to reach 134 percent of GDP next year.
Italian officials said the country has not set aside any funds for recapitalization purposes but will approve by the end of the year a legal framework for state aid to banks.
The Bank of Italy has said the 15 Italian banks that will undergo the health check needed 1.2 billion euros to meet an 8 percent minimum threshold on core capital set by the ECB.
But the International Monetary Fund has estimated that 20 Italian lenders could need a total of nearly 14 billion euros in Tier 1 capital under a worst-case scenario.
Germany is one of the few countries that has money set aside - so far about 1.8 billion euros - in a restructuring fund from a banking levy, of which 520.1 million was paid out in 2013.
That could prove to be a drop in the ocean.
Berlin bailed out its IKB bank in 2007 with billions of euros and then had to save Commerzbank with 18.2 billion. Dealing with the failed Hypo Real Estate bank required another 175 billion euros in state aid.
In case of a crisis, the German fund can raise additional contributions from banks. It is to reach 70 billion euros eventually.
France does not have any existing fund to recapitalize banks, and is likely to handle such operations through the state-owned Société de financement de l'économie française, which invested 20 billion euros in the largest banks - BNP Paribas, Société Générale, Crédit Agricole, Crédit Mutuel and BPCE - during the worst of the financial crisis.
The money has since been paid back and earned the state handsome profits through interest and dividend payments.
In Spain, the government gave its banks a 30 billion euro capital boost by allowing them to transform part of their so-called deferred tax assets into state-backed tax credits and count them as core capital under new global banking rules.
In the Netherlands giving banks government bonds to boost capital was possible, said Jan Sijbrand, director of banking supervision at the Dutch central bank.
Austria is another country which had money set aside for banks, although from a 15 billion euro backstop set up in 2008 to support struggling banks and insurers only 1.26 billion was still available as of March 31 this year.
Major Austrian political parties have agreed to earmark 5.8 billion over the next five years for additional bank aid.
Reporting By Annika Bredithardt in Berlin, Leigh Thomas in Paris, Julien Toyer in Madrid, Gisleda Vagoni and Giuseppe Fonte in Milan, Mike Shields in Vienna, Thomas Escritt in Amsterdam, Jussi Rosendahl in Helsinki. Editing by Mike Peacock