PARIS — European banks will be forced to write down the value of their holdings of government bonds and raise perhaps hundreds of billions of dollars in additional capital under plans intended to quell the euro region’s financial crisis.
The plan, outlined Wednesday by the European Commission, marks a direct acknowledgment that the government bonds purchased by banks as safe, low-risk investments are in some cases not worth what was paid. Recognizing that means banks will need more capital to absorb potential losses, and European officials — after skirting the issue for months — on Wednesday said the euro area’s financial system cannot be fixed otherwise.
“To restore confidence in the European Union banking sector, a coordinated, targeted recapitalisation effort is needed,” the plan concludes. While the needs of individual banks are to left to national regulators, the plan calls for a “prudent valuation of all sovereign debt.” That step could, by some analysts’ reckoning, prompt a near complete write-off of the value of Greek bonds, as well as sharp discounts on loans to Ireland, Portugal and other nations.
“To break the vicious cycle of uncertainty over sovereign debt sustainability and over growth prospects, we need comprehensive solutions now,” European Commission President Jose Manuel Barroso said as he released the “Roadmap to Stability and Growth.”
The document also calls for steps to enlarge the lending power of a European bailout fund to ensure that governments in the region have access to financing and to bring negotiations over a new bailout effort for Greece to a quick conclusion.
This is not Europe’s first response to the financial turbulence that has pushed three euro-region countries into international rescue programs, threatened others with the same and raised the specter of a Lehman Brothers-style collapse. And so far it lacks details, saying only in broad outlines that banks should try to raise private capital first before turning to the public again for help.
But international pressure has mounted on Europe to the point where top national leaders such as German Chancellor Angela Merkel appear poised to act more decisively.
Finance ministers from the Group of 20 top economic powers meeting this weekend will expect Europe to announce an “accelerated and forceful” program to prove that its banking system and government accounts can be stabilized, said Lael Brainard, U.S. Treasury undersecretary for international affairs.
“It is important to see the European plan and the mobilization of European resources” to address issues that have raised the risk of renewed recession, Brainard said Wednesday.
Details of the banking plan, a more realistic program for Greece and other measures are expected to culminate over the next three weeks as European leaders gather for a summit in Brussels this month and G-20 heads of state, including President Obama, gather in Cannes in early November.
The G-20 leaned heavily on Merkel and other top European politicians during recent Washington meetings of the International Monetary Fund, citing Europe’s travails as a central risk to the world economy. Since then, talks over how Europe should respond have accelerated, and European stock markets — including shares of major banks — have been rising. Data from the European Central Bank indicate that it has not had to intervene as aggressively in bond markets — possibly signaling some confidence that countries such as Spain and Italy will repay their debts.
But there are numerous hurdles.
Outgoing Italian central bank governor Mario Draghi said Wednesday that the government was “wasting time” in reducing its budget deficit, and Prime Minister Silvio Berlusconi faces a confidence vote this week over his handling of the nation’s budget and economic issues. Italy, with trillions of dollars in outstanding debt, is considered the core test for Europe’s economic strength. Banks will find it difficult to remain solvent if they are forced to take large write-downs on Italian bonds, or the country risks a default.