Potential losses on European government bonds could cost banks in the region $400 billion and threaten to wipe out several major insurance companies, the International Monetary Fund said on Wednesday in its first effort to quantify the costs of Europe’s debt problems.
The potential losses represent a major share of the capital held by some banks, and in the case of the insurance companies involve risks to the broader economy that the IMF acknowledges are not fully understood.
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In the U.S. financial crisis, the insurance company AIG played a major role in broadening the problem because it had absorbed so many different types of bad investments and had extensive ties with other financial firms.
IMF and European regulators said that they are fairly confident no equivalent exists in Europe and that the risks faced by insurance companies and other firms is “manageable” by European governments.
Still, the study laid bare some of the ways in which problems in Greece and elsewhere are dragging down the European economy and putting a tepid global recovery at risk. The United States is encouraging Europe toward more forceful action to address the debt problems.
The IMF has suggested banks raise more capital to prepare for possible losses on government bonds, saying they should aim to set aside an amount equal to 10 percent of their assets. On that basis, many of Europe’s core banks fall short, according to recent analysis by the European Banking Authority, suggesting they are not fully prepared for one of the chief risks they are facing.
The estimated losses took into account both bank holdings of government bonds in six “high-risk” countries — Greece, Ireland, Portugal, Spain, Italy and Belgium — and bank investments in other banks located in those countries. All told, the IMF estimated that about half of the euro area’s $9 trillion in outstanding government debt was now at “heightened credit risk.”
The study was released as the country at the center of Europe’s crisis, Greece, pledged further spending cuts to convince an international group of creditors that Athens is meeting the conditions of an international bailout program.
Without an $11 billion installment of bailout funds, Greek officials have said the Mediterranean nation will go broke by the end of October. But some analysts said Wednesday that the potential economic maelstrom from a sudden Greek default was so strong that it was unlikely that Germany and other euro zone nations would withhold the funds, at least this time around.
Greek Finance Minister Evangelos Venizelos told the nation’s parliament Wednesday that “we are doing and will do whatever it takes. We won’t put the country’s fate at risk.” The new cuts will slash government pensions, extend a property tax hike and put 30,000 civil servants on notice that they will lose their jobs in a year, a government spokesman said after a cabinet meeting Wednesday.
European financial officials said last weekend that they would decide in early October whether to release the money.
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