Doubts remain on European banks

FRANKFURT — European banks have grown nervous about each other’s creditworthiness, evoking memories of the mistrust that prevailed during the dark days of 2008.

The European institutions are better equipped in the event of a crisis than they were in 2008, according to analysts. But some still doubt that this armor is thick enough to withstand another big hit.

Despite the progress made since then in the rehabilitation of the financial system, according to analysts, some shortcomings remain, among which the persistent absence of any mechanism to deal with the failure of a large bank.

And while regulators have pushed banks to reduce risk, bolster reserves and become less dependent on volatile short-term funding, the measures were designed to be phased in over a decade. As a result, they are still below what some experts, particularly from the academic world, consider adequate.

“We should have solved these problems in the banking sector long before the last few months,” said Harald A. Benink, professor of banking and finance at Tilburg University in the Netherlands.

Many indicators of anxiety, such as emergency borrowing from the European Central Bank and interest rates on short-term loans, pointed to tensions in the interbank lending market. In particular, there are signs that some European institutions have had to pay more to borrow dollars.

“There is no doubt that unsecured US dollar funding markets have tightened somewhat recently,” Andreas Dombret, a member of the board of directors of the Bundesbank, the German central bank, acknowledged on Wednesday. Money market funds in the United States “have become more selective in providing funds to non-domestic banks,” Dombret said.

But, like others who argue that fears of another crisis are overblown, Mr Dombret says banks are doing much better than they did three years ago.

German banks, he said, have increased the capital they hold in reserve by around three percentage points since 2008, to an average of 12.6% of assets. This means that they are better able to absorb losses should bad debts increase or the value of their government bonds decline.

“We are a long way from the situation we saw in 2008,” Dombret said during an appearance at a Bundesbank office in New York, according to a text of his remarks. “European banks, in general, have significantly improved their capital base, making them less vulnerable to financial stress.”

But some critics say the level of capital is still insufficient in the event of another major crisis, especially for very large banks or interconnected banks that would spread destruction throughout the system if they failed.

Central bankers and regulators have made diligent efforts to make the system less vulnerable to the problems of these banks, known in regulatory jargon as systemically important financial institutions, or SIFIs. For example, too-big-to-fail banks will be required to hold more capital in reserve than other banks. But in Europe, few or no measures are in place.

“What we’re doing is good, but it’s taking too long,” said Renato Maino, a former executive in the risk management department of Italian bank Intesa Sanpaolo, now a lecturer at the University of Turin. “We have not removed the main sources of our financial instability.”

Fear that another major bank failure could be imminent may help explain why markets reacted so nervously when a single bank last week took advantage of a European Central Bank program aimed at preventing institutions from running out of dollars, as many did during the 2008 crisis. The unidentified bank borrowed $500 million for a week, the first time a bank has used the central bank’s line of credit since February.

The sum was large enough to suggest that the borrower was a large bank with significant business in the United States – a SIFI, in other words.

It was a theory. Another explanation, a little less alarming, was that the dollar-hungry bank was one of the German lenders known to have bought up US subprime assets before the housing market crashed. These assets are still on the bank books and may need to be refinanced, creating a need for a lot of dollars.

The uncertainty has contributed to sharp declines in shares of major European banks and may reflect investor fears that governments, already awash in debt, may not be able to fund another round of bank bailouts.

The central bank lends to banks as much as they want for up to six months, on the condition that the banks provide collateral. But the central bank is not set up to save a failing bank.

“All banks can borrow as much as they need, but at some point if it’s a solvency problem, it’s a problem for governments,” said Dirk Schoenmaker, dean of the Duisenberg School of Finance in Amsterdam.

The funding problems that banks are experiencing stem from the sovereign debt crisis and the growing fear that Italy and Spain will join the countries unable to pay their debts.

Several of the banks most battered by stock markets in recent weeks, such as Societe Generale in France and Commerzbank in Germany, also hold large portfolios of Italian bonds, according to European regulators.

Holding government bonds has an insidious effect on how banks are perceived by the markets. Investors fear that bonds will suffer losses. Bonds lose their value as collateral in interbank lending transactions, forcing banks to use more expensive forms of credit.

In addition, banks’ credit ratings are closely tied to the credit rating of their home country, according to research by the Bank for International Settlements, a clearing house for the world’s major central banks based in Basel, Switzerland. .

So when rumors swirled in early August that France could face a downgrade, French bank stocks were punished.

The negative effects are amplified when banks seek financing in the United States, according to the study by the Bank for International Settlements. This may reflect greater skepticism in the United States about the survival of the euro.

Because so much interbank lending takes place in secrecy between institutions, even banking industry insiders have trouble telling which of their peers are cash-strapped.

“I guess the markets are too nervous,” Mr. Schoenmaker said. “But,” he added, “markets are normally right.”