European banks are facing a reckoning over hundreds of billions of dollars in loans extended to the continent’s cash-strapped governments with potential losses so large, if countries default, that some financial firms could be put out of business.
The tumbling value of government bonds issued by some European governments is already undermining the health of major banks. On Wednesday, Moody’s Investors Service cut the credit rating of two large French banks, due to their holdings of Greek government bonds and to wider concerns about whether investors will continue to trust European banks with their money.
Banks on the edge
Jeffrey Sachs, an economics professor at Columbia University, talks about the European debt crisis, the U.S. economy and imbalances in global living standards. (Sept. 14)
On Thursday, the European Central Bank announced that it would provide European banks loans in dollars to help shore up investor confidence. The ECB said it would coordinate with the Federal Reserve, Bank of England, Bank of Japan and the Swiss National Bank to offer three medium-term loans through 2011.
If a major bank were to fail, that could send shock waves across the Atlantic, buffeting U.S. financial companies with close ties to their European counterparts or major investments in Europe.
The downgrades by Moody’s added fuel to a debate among European and U.S. policymakers over whether the continent’s banks are mostly healthy or instead need billions of dollars in additional capital to withstand likely losses on loans made to countries such as Greece, Portugal and Italy.
Greek bonds are already being resold at half their face value because of the high risk of default. If these losses mount, they could eat away at the capital buffer of banks across Europe, raising the prospect of an outright bank failure — which some financial analysts fear could cause the global financial system to seize up as it did after the Wall Street investment bank Lehman Brothers collapsed in 2008.
Capital point of contention
The question of whether European banks are dangerously short of capital will be a point of contention as European finance ministers gather in Poland on Friday and the International Monetary Fund holds its annual meetings next week. IMF Managing Director Christine Lagarde has argued that European banks need a quick and large capital infusion, and U.S. Treasury Secretary Timothy F. Geithner in a CNBC interview on Wednesday said that European leaders are “behind the curve” in addressing the region’s banking and other problems.
In cutting the rating of Credit Agricole, Moody’s cited the French firm’s “sizeable exposure to the Greek economy.” The rating company downgraded Societe Generale because of broader concerns about the outlook for French banks. This action may make it more difficult or more expensive for the banks to raise the money they need to operate — bad news in an environment where financial firms already mistrust each other and are charging more to lend to each other.
French bank officials have said they regard their capital buffers as adequate, and French central bank governor Christian Noyer on Wednesday said Moody’s action was “relatively good news.” With some investors predicting that Moody’s would slash the banks’ rating even more, Noyer told French radio, “It’s a very limited downgrade,” according to wire service reports.