European politicians on Thursday rejected an International Monetary Fund call for banks to raise up to 200 billion euros ($290 billion) in new capital, adding to fears that policymakers may be underestimating the severity of the debt crisis.
IMF chief Christine Lagarde's call on Saturday for mandatory capitalization of European banks to prevent a world recession has reignited a debate over whether they have raised sufficient capital to withstand a severe downturn.
The IMF, the International Accounting Standards Board (IASB) and bank analysts have voiced concerns about a capital shortfall, while European regulators, politicians and banking associations argue that banks have a sufficient cushion to cope with market turbulence and worries over sovereign debt after several rounds of capital raising across the continent.
A European source told Reuters on Wednesday that the IMF had estimated European banks could face a capital shortfall of 200 billion euros, a figure rejected by European bankers and policymakers.
The IMF figure is much higher than European Union estimates of banks' capital needs following stress tests in July which showed banks needed to raise 2.5 billion euros ($3.6 billion), less than had been expected before the tests.
The stress tests failed to account for significant losses on sovereign debt held on bank balance sheets, a factor criticized this week by accounting body IASB, which said European financial institutions should have been more consistent in booking losses on Greek government bonds.
Writedowns disclosed in bank results have varied between 21-50 percent.
European Union Competition Commissioner Joaquin Almunia said on Thursday: I think we should trust in our stress test exercise. It is much more detailed and is a bottom-up exercise. The IMF is a top-down exercise based on estimates on the evolution of credit default swaps.
However he cautioned that the tests, which gave an accurate picture of banks at present, could be overtaken by events.
I think the stress tests were correct, unless we would not be able to manage the sovereign debt crisis, he said, but didn't want to elaborate.
European banks became more expensive to insure against default on Thursday, mirroring a trend in the broader market, with French banks in particular taking a knock.
The iTraxx Senior index and iTraxx Main were both quoted 2.4 percent wider.
At 1555 GMT, credit default swaps (CDS) on French bank Societe Generale
In a note sent to institutional clients on August 16, a Goldman Sachs strategist argued that European banks needed as much as $1 trillion in capital, The Wall Street Journal reported. The report did not make clear by when the capital was needed.
Matthew Clark, banking analyst at Keefe Bruyette & Woods said it was important to determine the nature of a capital shortfall, and to distinguish between banks struggling to refinance themselves on a day-to-day basis and banks that can use retained earnings to meet future requirements.
Key parts of the Basel III regulations do not come in to force until 2013, Clark said, giving banks some time to plug the gap.
European bank shares were lower at 1629 GMT, with the Stoxx 600 banking index <.SX7P> down 1 percent.
Figures on Thursday also showed euro-priced bank-to-bank lending rates edged higher, driven by concerns about the outlook for the economy and euro zone banks.
The fight over whether European banks have sufficient capital highlights a flaw in the accounting treatment of sovereign debt, experts say.
One enormous weakness is that European banks are encouraged to load up on sovereign debt without pricing in the appropriate risk penalty, said Roger Myerson, winner of the Nobel memorial prize in economics in 2007. It creates the wrong incentives for governments and banks.
Myerson, who was recognized for his contributions to mechanism design theory, said that under Basel accounting rules, sovereign debt is still given a risk weighting of zero.
This encourages banks to buy risky debt without having to build an appropriate capital cushion, and provides an incentive for governments not to address their deficit levels since they are still able to issue debt.
This looks like the entire problem of the euro zone, Myerson told Reuters.
Eurozone governments and the European Central Bank disagree with the very questionable methodology of the IMF estimates on bank capital requirements, a European government official said. The European Central Bank declined to comment.
The European Commission reiterated on Thursday it saw no need for drastic action since the publication of the stress test results, echoing comments made by the European Banking Authority on Tuesday.
The view was echoed by the German Banking Association BdB which represents lenders such as Deutsche Bank
France took a similar line on its banks, whose shares came under intense pressure during August amid concerns over access to funding, with French Budget Minister Valerie Pecresse saying they were not a cause for concern.
($1 = 0.695 Euros)
(Reporting By Edward Taylor, Philipp Halstrick and Marc Jones in Frankfurt, Jan Strupczewski in Brussels, Lionel Laurent in Paris, Gilbert Kreijger in Amsterdam, Douwe Miedema and Andrew Perrin in London, and Mike Shields in Alpbach, Austria; Editing by Will Waterman, Alexander Smith and Erica Billingham)