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Banks Can’t Shrink Lending to Meet EU Targets, Enria Says

Regulators won’t allow lenders to cut lending to companies to circumvent tougher European Union capital requirements, the head of the region’s banking watchdog said.

The European Banking Authority is seeking to ensure that lenders bolster their capital by raising fresh reserves, rather than by threatening the economy by running down loans, the agency’s Chairman Andrea Enria said in Brussels today.

European policy makers are trying to avoid triggering a credit crunch and recession with their plans to force banks to boost capital. One way for banks to increase their capital ratios is for them to shrink their balance sheets by cutting lending. Banks are likely to reduce their balance sheets by as much as 2.5 trillion euros ($3.4 trillion) within the next 18 months, Morgan Stanley analysts said in a report last month.

The shrinkage that lenders have already begun is “a serious threat” to growth in the 27-nation EU, Enria said. The EBA is insisting that “only the narrowest actions curtailing asset levels” such as loans would be allowed to count toward lenders’ capital levels, he said.

European leaders are demanding the region’s banks increase their capital after financial firms agreed to accept losses on Greek government bonds. Enria was speaking ahead of the EBA’s release of updated figures on how much capital lenders should raise to absorb losses from euro-area bonds.

Sovereign Debt

The EBA estimated in October that the region’s financial institutions need 106 billion euros to reach a requirement to hold 9 percent of so-called core Tier 1 capital by mid-2012, after marking their sovereign debt to market prices.

Capital requirements for banks are set as ratios of their reserves compared with loans and other assets weighted according to their riskiness.

EU lenders have been facing a “funding squeeze” since the summer that “is closely linked to the sovereign debt crisis,” Enria said. Data from the European Central Bank had shown that funding situation was the “main cause” of a retrenchment in lending, he said.

Seventy banks were tested in October with data broken down by country. Spanish banks needed 26.2 billion euros and Italian banks 14.8 billion euros in core tier 1 capital, taking into account booking sovereign debt at market prices, the EBA has said.

Capital Needs

Enria declined to indicate when the updated figures on banks’ capital needs will be published.

Separately, Enria commented on plans by Michel Barnier, the EU’s financial services chief, to propose draft rules to end the need for taxpayer bailouts of failing banks.

Enria said plans to write down unsecured creditors at failing banks should exempt debt issued before a cut-off date.

This is needed to prevent the proposals “exacerbating” difficulties lenders are facing in getting funding, he said.

Enria also said that plans by individual nations to force banks to accelerate the implementation of bank capital rules drawn up by the Basel Committee on Banking Supervision could “aggravate” funding problems faced by lenders in other nations, as investment would gravitate to the jurisdictions with the toughest rules.

Liquidity rules set by Basel will “have to be carefully reviewed and calibrated,” he said.

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