EUROZONE BANK DISTRESS TESTS

The 'final' figure is in - the European Banking Authority (EBA) has set a target of €106bn in fresh capital to prop up Eurozone bank balance sheets.  This assumes a Tier 1 capital ratio of 9%, with funds to be raised by 30th June 2012.  As noted on Zerohedge, the figure falls "below the €200 billion projected by the IMF, the €400 billion projected by Credit Suisse, and €1 trillion calculated by Goldman Sachs. Granted the number excludes a further €40.6 billion in sovereign capital buffer, so altogether the number is about €147 billion."

Where will the bank capital injections come from?

"Rather than tapping investors or governments, firms are trying to hit the 9 percent core capital target by adjusting risk-weightings, limiting dividends, retaining earnings, reducing loans and selling assets. Banks had threatened to curb lending, risking a recession, to meet the goal rather than take government aid that would bring limits on bonuses and dividends. EU leaders already are pressing banks to restrain payments to employees and shareholders until they meet the capital target."
- Bloomberg News 31/10/11

To stop this disaster turning into a catastrophe, the EBA explicitly stated how banks may/may not raise required funds:

"The targets will have to be achieved avoiding excessive deleveraging, so as to contain the potential impact on the real economy. To reach the targets, banks will be expected to withhold dividends and bonuses.  The capital needs will be met only with capital of the highest quality."
- EBA Communication 26/10/11

I guess banks missed the EBA memo!

The graphic above is based on calculations by Thomson Reuters.  The 'best case scenario' shows additional bank capital needed under Reuters' "original figures" based on a 7% capital target (€93.2bn).  The worst case scenario provides capital required were the target raised to 10% and the PIIGS wrote-off all their debt (€903bn).  [Best case scenario is obviously for no extra capital due to a healthy economy and banking system, but a bit late for that!]

The tool performs a useful function for evaluating potential future scenarios, bringing up some interesting results:

- 7% Tier 1 target with no haircuts on PIIGS' debt still leaves €42bn capital shortfall (Scenario 1)

- 9% Tier 1 target with no haircuts means €194bn additional capital is required (S2)

- Compared to "Original" a 2% increase in Tier 1 target requires almost as much capital to be raised as a 49% haircut being applied to all PIIGS with no Tier 1 capital change (€260bn v €273bn, S3 v S4)

- Splitting the PIIGS, a PIG haircut of 49% which helps Italy and Spain fulfill all their debt obligations requires less capital than "original figures" (€85bn v €93bn, S5 v Original)

- Worst case scenario = Game Over....?

Capital Shortfall under various Capital Ratio and Sovereign Haircut Scenarios:

Scenario	T1 Capital Ratio	Portugal	Italy	Ireland	Greece	Spain	Capital Shortfall, €bn	#Banks Failing
Original	7%	26.5%	4.6%	11.6%	63.1%	0.4%	93.2	47
S1	7%	0	0	0	0	0	41.5	42
S2	9%	0	0	0	0	0	194.2	65
S3	9%	26.5	4.6	11.6	63.1	0.4	259.6	67
S4	7%	49	49	49	49	49	273.2	63
S5	7%	49	0	49	49	0	85.2	48
Worst	10%	100	100	100	100	100	903.3	82

Should the actual requirements turn out closer to Credit Suisse or Goldman Sachs' estimates (after all, no estimates appeared the same so who really knows the 'real' number), that's a lot of donuts to be given out at bank bonus time!  Or a lot of assets to be sold anytime....

If you'd like to run your own scenarios with an easy-to-use interface, click here to access Thomson Reuters Graphics.