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EU to Set June 2012 Target for Banks to Reach 9% Capital

European Union leaders have set a deadline of June 30, 2012, for banks to have core capital reserves of 9 percent after writing down their holdings of sovereign debt.

The reserves must be of the “highest quality,” the leaders said in a statement after a summit today. Lenders are expected first to tap private sources to make up any capital shortfall and “should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained.” The statement doesn’t give an estimate of total capital EU banks must raise to comply with the rule.

Measures for restoring confidence in the EU’s banks are “urgently needed,” the statement says. They should include steps to “ensure the medium-term funding of banks, in order to avoid a credit crunch and to safeguard the flow of credit to the real economy.”

European leaders are meeting to hammer out an agreement on bolstering the region’s rescue fund, recapitalizing banks and relieving Greece to avoid contagion spreading to Italy and Spain. The summit is part of an attempt to solve the two-year-old sovereign-debt crisis that has pushed Greece closer to default, roiled global markets and dented confidence in the survival of the euro.

Gauging Reserves

The leaders of the 17 euro nations are now meeting separately and no time for a conclusion of the talks has been given.

Banks’ reserves should be measured after “accounting for market valuation of sovereign debt exposures” as of Sept. 30 2011, the statement says. Lenders should be prepared to resort to restructuring and “conversion of debt to equity instruments,” to meet the required level of reserves.

To help European lenders shoulder sovereign losses, banks may be required to raise about 100 billion euros ($139 billion) in capital by mid-2012, two people briefed on the matter said earlier this week. The European Banking Authority tested lenders to see how much money they’ll need after writing down bonds from countries such as Greece, they said.

Alongside the recapitalization plans, the EU is trying to reach an agreement with banks on voluntary writedowns on their Greek government bonds to help reduce the country’s debt load. French President Nicolas Sarkozy and German Chancellor Angela Merkel want to meet Greek creditors in Brussels tonight to break a deadlock on the terms of a debt writedown, said a person familiar with the matter.

‘Safety Net’

The Polish finance minister, Jacek Rostowski, speaking to reporters today after the EU meeting, said recapitalizing banks is needed to allow the private-sector involvement, or PSI, on Greece to “proceed safely.”

“The recapitalization agreement provides a safety net for the PSI for Greece, ensuring that there won’t be contagion effects from that,” he said. “As regards to the actual quantity involved, that will of course in part depend on the PSI for Greece itself, but above all it’s going to be announced in due course by the European Banking Authority and not here at the summit.”

Regulators should ensure that capital requirements on lenders don’t “lead to excessive deleveraging, including maintaining the credit flow to the real economy,” the statement says. Authorities should also “avoid undue pressure” on lending by banks’ subsidiaries in other EU nations.

‘Simple Repetition’

The European Commission, the 27-nation EU’s executive arm, will be charged with “urgently” exploring how to coordinate national measures to support banks’ access to medium-term funding, including by guaranteeing lenders’ liabilities.

“A simple repetition of the 2008 experience with full national discretion in the setting-up of liquidity schemes may not provide a satisfactory solution under current market conditions,” according to the statement. Guarantees on bank liabilities should be provided “where appropriate.”

Any public support to banks would be assessed by the commission in line with EU state-aid rules, the statement says. Still, these rules will be applied with “necessary proportionality” in view of the systemic nature of the crisis.

The EU relaxed rules on how far states can subsidize banks in 2008 and has required lenders to shrink balance sheets to compensate for the advantage they gain over rivals from billions of euros in government recapitalization and guarantees.

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