Europe’s banking system would need as much as 250 billion euros ($355 billion) of new capital if faced with a “sharp” increase in yields and a “severe” economic contraction, Standard & Poor’s said in a report.
The ratings company imagines three stages happening from 2011 to 2015, including soaring yields triggered by an interest- rate shock, restricted market access for weaker sovereigns and a “very severe” downturn in the economies of Greece, Ireland, Portugal and Spain. Under this scenario, stress in Italy would be “substantial,” while in France, Germany, the U.K. and the rest of the European Union it would be “moderate,” according to S&P.
Of S&P’s sample of 99 financial institutions covering 70 percent of Europe’s banking system, 22 would need new capital at a total cost of about 161 billion euros, according to the report. Extending that to the full European banking system would cost 200 billion euros to 250 billion euros, or about 2 percent of economic output of those lenders’ jurisdictions, S&P said.
“The overall effect on the creditworthiness of western European countries, if it were to happen, would be severe,” S&P analysts led by Paris-based Chief Credit Officer Blaise Ganguin and European Economist Jean-Michel Six, said in the report. “It would lead to substantially higher debt levels for all sovereigns throughout the region; hardly sustainable fiscal positions,” as well as the bank recapitalizations.
The scenario is based on “assumptions that do not reflect our current thinking,” including that the rest of the world isn’t affected by “major stress,” and that issuers don’t take “corrective action,” S&P said.
“In recent downturns we have repeatedly observed that high investment-grade issuers show significant resilience across sectors,” the analysts wrote. They can “adjust rapidly by diversifying their revenue streams, reducing costs and paring down their investment programs,” they wrote.
The analysis is also influenced by a sample that isn’t a perfect reflection of the economy, according to the report.
The most affected issuers would be sovereigns, local and regional governments, speculative-grade companies and regional banks, the analysts wrote. The least affected would be large, geographically diversified companies and banks, as well as insurers.
In the extreme stress scenario, which assumes a 20 percent cumulative economic contraction over five years in Greece, Ireland, Portugal and Spain and “lesser, yet still-painful adjustments” for other nations, sovereign borrowing needs would soar, according to the report.
Greece’s gross borrowing need would increase to 179 billion euros in 2015, compared with 57 billion euros under S&P’s base case scenario, according to the report. In Ireland it would double to 38 billion euros from a base case of 19 billion euros that year, S&P said. Spain’s gross borrowing need would more than double from the base case, rising to 346 billion euros from 151 in 2015, according to S&P.
New York-based S&P assumes that governments would recapitalize banks with Tier 1 capital ratios that slip below 7 percent. In the stressed scenario, five Spanish lenders fall below that level and require support, while Greece, Italy and Ireland each have to prop up four. Germany would need to put new money into two banks, according to the report.
The Spanish banking system would suffer the most in absolute terms, requiring close to 64 billion euros in support, or about 6 percent of economic output, S&P said. Greece would be hardest hit in relation to the size of the economy, needing about 34 billion euros, equivalent to 15 percent of gross domestic product, according to the report.
To contact the reporter on this story: John Glover in London at email@example.com