The International Monetary Fund urged Europe on Wednesday to pump as much as 200 billion euros into its banks and warned of a freeze in lending and an ensuing recession if the region's leaders failed to do more to reassure panicky investors.
Europe has shown resistance to an IMF call in August to protect its banks from the fallout from a possible Greek default, but the IMF's European head, Antonio Borges, said pan-European recapitalization was crucial to restore confidence.
We are talking about figures of between 100 and 200 billion euros, which in our view is very, very small compared to the size of the European capital markets and compared to the resources of the new, enhanced EFSF, Borges told Reuters during a visit to Brussels, referring to the euro zone's 440 billion euro rescue fund, the European Financial Stability Fund (EFSF).
The EFSF, set up in May last year and used to bail out Ireland and Portugal, will be allowed to lend governments money to recapitalize banks once its secures new powers likely to be ratified soon by all governments in the 17-nation euro area.
France in particular has been shaken by anxiety that its top banks are too exposed to Greece, whose debt will end 2011 at 357 billion euros, or about 160 percent of gross domestic. The troubles facing Franco-Belgian bank Dexia have also thrown Europe's wealthy heartland back into focus.
Borges said Europe could not ignore reality.
There has been a lot of talk about French banks, but ... the problem is very widespread, he said. No banking sector in the world can sustain a generalized loss of confidence and we need to restore that confidence all over Europe.
The European Union's executive Commission acknowledged on Wednesday that confidence in Europe's banks had deteriorated since the 27-nation bloc gave more than 80 banks a clean bill of health over the summer in tests that investors regarded as too soft.
The EU says member states have already injected 420 billion euros into its banks since 2008, but Borges said the issue was no longer about whether banks were strong or not, but about perception.
He said a freeze in bank lending could worsen Europe's troubles, as manufacturing slows and business confidence tumbles across the region. That was more of a threat than dramatic cuts in government spending.
The concerns about the possible recession in Europe, which are real ... are much more related to problems in the financial sector and the possibility of a real credit crunch, he said.
ECB HELP, GREEK DEFAULT NO SOLUTIONS
Ideally, European leaders would agree a broad bank recapitalization quickly, Borges said.
We would certainly recommend that it should not be country by country, and not limited to one country. All large European banks should have a significant injection of capital under the same conditions for everyone, Borges said.
While the euro zone's rescue fund could be used to help banks once it secures its new powers, European leaders could not rely on the European Central Bank playing a central role in increasing its capacity, Borges added.
When people talk, perhaps loosely, about leveraging the EFSF, they have in mind using the EFSF in a very targeted manner in order to bring other investors back to the market for sovereign debt, an intervention that would restore confidence, he said.
I think everybody is aware that even this much larger EFSF has limited resources and has to be used efficiently.
Borges argued that calls by some investors for Greece to default and start afresh were misleading and said the IMF would definitely participate in a second bailout package for the country if it felt Athens was genuine about its intentions to resolve its troubles.
A default would not solve the problem. Greece is a country with a very large current account deficit and a rather large primary deficit, he said, adding that Greece would still be dependent on international financing after a default.
If there is a second program for Greece, which is the expectation, I think the IMF will definitely participate, on the condition that we remain convinced that Greece is on track and the right policies can be put in place, that debt can become sustainable, he said.
(Writing by Robin Emmott; editing by Rex Merrifield/Mike Peacock)