S&P Sees Deeper Europe Bank Crisis on Fears of Sovereign Default

Ahead of summit meeting, credit agency S&P raps stress tests; European Commissioner raps credit agencies

The European Central Bank building in Frankfurt, Germany. (AP Photo/Bernd Kammerer) The European Central Bank building in Frankfurt, Germany. (AP Photo/Bernd Kammerer)

Credit rating agency Standard & Poor’s has joined the chorus of dissatisfaction with Europe’s bank stress tests, saying the risk of sovereign default should have been a factor in the tests.

The tests, released Friday after trading, found that just eight out of 90 banks tested would have insufficient Tier 1 capital in an adverse economic scenario. But GFS News, which covers financial regulation, quotes an S&P report saying Europe’s shaky financial institutions depend on a government infusion of capital, support which could be undermined by a sovereign default.

“Of the €1 trillion ($1.4 trillion) of core Tier 1 capital held by the 90 banks stress tested at the end of 2010, 16 percent had been provided by governments or other public sector entities,” S&P credit analyst Richard Barnes said.

European and world markets have been rocked for two years by fears of a sovereign default, yet the European Banking Authority’s stress scenario did not include the possibility of a sovereign default by Greece, Portugal, Spain or Ireland. Eurozone leaders gather Thursday in an emergency summit meeting on the debt crisis in Europe, where a default by Greece is considered imminent barring a large-scale and politically complicated bailout.

One issue that is sure to be discussed is whether and how private investors might contribute to resolving the problem. The credit agencies have said they will consider any private participation in restructuring of Greek debt tantamount to a default, but the European Central Bank has said it cannot accept defaulted debt securities as collateral. Consequently, anything other than a Eurozone government bailout could push shaky European banks holding Greek government debt off the ledge, with repercussions throughout Europe’s financial system.

In an interview one day ahead of the Eurozone emergency summit meeting, European Commissioner for Internal Market Michel Barnier disagreed with the European Central Bank’s resistance to private participation in a Greek bailout, but offered a novel approach. Barnier told Euronews it is important “that the private sector participates in the recovery of countries such as Greece, and it maintains its level of exposure. It’s not a question of accepting default so much as offering support.”

Rating agency opposition to this idea rests on the notion that banks accepting a “haircut” means Greece is paying less than it owes. In other words, the credit agencies view private participation in restructuring as a default.

Barnier’s response is that Europe needs its own credit agencies: “But it’s also important to reduce the influence of these ratings, to reduce the dependence on these ratings. These ratings are used too much in drawing up regulations, all regulations including the banks. What I’m proposing today is that the banks make their own judgments without relying on what these agencies say.”

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