European Commission Urges Banks to Raise Capital

Presenting a broad new crisis plan on Wednesday, President of the European Commission José Manuel Barroso said banks in Europe should temporarily raise their capital reserves to better weather markets made turbulent by the region’s sovereign debt problems. Barroso also said that key European banks should not be allowed to pay out dividends to investors, nor should they pay their executives bonuses, until they have raised their capital buffers to the new standards.

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Banks could be facing huge losses on government bonds from countries like Greece, and that possibility has been stifling lending, both between banks and to the wider economy, threatening to throw the euro zone into another recession. While Barroso did not give a specific figure for the new capital cushions, his full proposals, published on his website following his speech, suggest that his proposal could require an accelerated implementation of the so-called Basel III rules.

The Basel III rules are new international rules on bank capital, which increased the amount of low-risk assets that banks had to hold to back up their lending and investments in order to decrease the chances the banks would fail. Ultimately, it will be up to the national banking supervisors, as well as the European Banking Authority, to define when the higher capital ratios must be attained, how long they must be elevated, and what the precise ratio should be, according to a spokesman for Barroso.

Barroso suggested that banks’ exposure to all sovereign debt be taken into account “in a transparent way” when assessing their capital needs.  The Commission also asked for a “prudent valuation of all sovereign debt, whether in the banking book or the trading book” of banks. If banks can’t raise the necessary capital on the market, Barroso suggests they should seek help from governments, who can in turn ask for money from the euro-zone bailout fund.

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Barroso also called for the European Stability Mechanism, the permanent bailout fund meant to replace the European Financial Stability Facility, to come into force in mid-2012, a whole year ahead of schedule. The new stability mechanism, unlike the EFSF, will require private investors to take losses on government bonds if a nation needs to write off some of its debt load.