Europe has for months stood unified in its public position that it will be able to withstand the developing financial maelstrom because its banks are healthier than U.S. banks. Over the past few days, however, that position has changed.
Belgian, French and Luxembourgian authorities have stepped in to shore up Fortis Bank. Irish, German and Danish governments have announced guarantees to backstop private bank deposits. And the Swedish government has increased the level of its deposit guarantees.
Separately, the U.K. unveiled plans for a £50 billion ($87.18 billion) bailout. Broadly speaking, the U.K. bailout entails £50 billion of capital (£25 billion to be invested shortly with a further £25 billion if required) will be made available to U.K. banks and building societies in the form of preference shares, PIBS, or equity. The government will guarantee all short- and medium-term debt issuance, and will make available a £200 billion Special Liquidity Scheme.
Institutions that have committed to raise Tier 1 capital by a combined £25 billion are: Abbey National, Barclays, HBOS, Lloyds TSB, Nationwide, Royal Bank of Scotland, and Standard Chartered. The U.K government said it will take dividend policies into account, as well as executive compensation practices, and will require a full commitment to support lending to small businesses and home buyers.
Spain also said that it will spend as much as >50 billion ($68 billion) to buy assets from its troubled banks.
What effect is all this going to have on market confidence? It could be a step in the right direction. Alone, the measures taken toward improving liquidity via the central banks' repo program have done little to restore confidence. The combination of central bank intervention and government guarantees, however, could provide a winning formula.
Alan Brown, CIO at Schroders, said that Europe is not in a need of a TARP-like rescue, and instead points to the importance of these government guarantees, which European banks will now have access to.
"It seems to me that, above all else, we need banks to get fresh capital, so capital injections may be one path to go down," he said. "The other issue we now need to recognize as it spreads across Europe is the issue of guarantees. Guarantees will keep savers in place and avoid the run on the bank that we all fear. The price for this though is going to be that holders of bank equity or bank debt are likely to be left with very little if that institution becomes one of the ones that governments need to take care of."
The rescue for European banks is being executed on a piecemeal basis. Some market observers believe that for these individual actions to be most effective, there is a need for countries that have done little as of yet to directly address the issue of bank recapitalization. They said that interdependence among European banks is too deep for coordination on a country-by-country basis to be enough.
However, when France was said to be shopping the idea of >300 billion ($410 billion) European Union-wide rescue, criticism, especially from Germany and the U.K., was high. No one wanted to make the taxpayer foot the ultimate bill. The belief is that, with a little help, these banks can get through the storm, and if governments can pledge support perhaps they can stave off panic-driven responses by both average citizens and investors.
The problem is that as countries devise individual rescue operations, divisions have begun to emerge. This has prompted a flight of capital to lenders enjoying deposit guarantees from lenders without government support.
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