Bank discrepancies will be a major topic for debate during the upcoming summit of European leaders. The main unknown lies in what should be done with the banks in order to eliminate doubt and provide new financing in the markets. One idea that has been considered is to forgive debt for all portfolios comprised of sovereign debt bonds. Still, that would be crazy and send banks searching for funds en masse, which would condemn us to utter collapse.
So the liquidity problem has become one of solvency. Was it not a good idea to reinforce firewalls around solvent countries such as Italy and Spain so that they can have time to straighten out their finances and need to create additional buffers to absorb greater losses? It was a big favor that shares are valued at market prices, so-called mark-to-market levels, which is something that would greatly benefit our two biggest lenders: Santander and BBVA. Both lenders have the largest market share and therefore will not have to register capital losses.
Nonetheless, that would not be the case for other Spanish lenders. Nor for the French, because they have opposed this approach given their AAA rating would be in danger if they were forced to use a mark-to-market strategy to recapitalize their financial system. So another consideration is to raise base capital requirements by 10% of shares of active risk.
That formula would allow lenders to trim their balances, thereby reducing risk and improving their solvency. That is, they would cut back their credit even more, throwing Europe into another spiral of recession.
In that case, it would be best if lenders were to look for a fixed amount of funds instead of determining them based on capital ratios. Even better would be to elevate funds such that the protective barrier around Spain and Italy becomes insurmountable. Still, all indicators suggest that we are going to receive an insufficient amount of cash to propel the recovery. And we already know good and well what that means: in just a few weeks European leaders will have to hold another summit in order to renegotiate terms all over again. Greece underscores how half-hearted patches lead to even bigger holes.
