Banks row hampers EU bid to halt credit freeze

BRUSSELS/MILAN Wed Nov 30, 2011 2:12pm EST

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BRUSSELS/MILAN (Reuters) - European Union finance ministers abandoned the idea of a pan-EU guarantee scheme for banks and the announcement of details of a bank recapitalization plan was delayed amid tensions over how to support banks and address a credit freeze.

As the EU's finance ministers met on Wednesday, the world's major central banks acted jointly to provide cheaper dollar liquidity to starved European banks facing a credit crunch.

The ministers had been due to sign off details of a 106-billion-euro plan to recapitalize banks, intended to revive confidence among nervous counterparts who have shunned EU lenders.

But a backlash from countries like Italy, which can no longer borrow at affordable rates and would struggle to find the nearly 15 billion euros the EBA watchdog said it needed to help its banks, has raised doubts over the program.

The head of the Italian markets authority Consob questioned the way the EBA (European Banking Authority) had worked out the banks' capital shortfall and said a drive to strengthen their finances risked exacerbating a credit squeeze.

Giuseppe Vegas told la Repubblica daily on Wednesday that Consob is in talks with the Bank of Italy to ask for a reassessment of these rules.

"In Italy there is a banking worry," Vegas said. "Money is not circulating anymore. The main risk is a spread of a credit crunch."

The EBA, which is in charge of the recapitalization drive, has said Italian banks need almost 15 billion euros in order to reach a tier one capital ratio of 9 percent by June next year.

Other countries such as Germany have also challenged the EBA over its calculations.

ECB ACTION

The remarks from Vegas echo recent comments from Giovanni Ferri, an academic who sits on the EBA's expert advisory group, who argued that Italian banks should not be forced to make provisions for a collapse in value of the country's bonds.

"Including the exposure to bonds of their own country to assess banks' recapitalization requirements makes no sense, since a bank is in any case affected by the default of its own country," he said, adding that recapitalization would do little to protect banks in such circumstances.

The ministers rejected proposals to combine state guarantees across the EU into a single scheme for banks, an idea academics and financial experts had said was necessary.

It will now be up to individual countries to stand behind their lenders if they experience difficulty borrowing.

But Luxembourg's Luc Frieden warned in the meeting that such national guarantees were unlikely to work in tackling a European wide problem, said one official present.

While such a move may work for economically strong countries like Germany, it will do little to lift confidence in banks in weaker states such as Spain or Portugal.

A similar guarantee by Ireland for its financial system ultimately overwhelmed it, forcing it to seek an international bailout.

If banks and countries are struggling to raise capital, they can theoretically turn to the euro zone's EFSF rescue fund as a last resort, although that has also been thrown into doubt by the struggle to leverage up the EFSF's own resources.

The political impasse on both fronts adds to the case for the European Central Bank to further intervene.

On Wednesday, the U.S. Federal Reserve, the European Central Bank, the Bank of Japan and the central banks of Britain, Canada and Switzerland acted, a move similar to coordinated action to steady global markets in the 2008 financial crisis.

Last week, people familiar with the matter said the ECB was looking at extending the term of loans it offers banks to 2 or even 3 years to try to prevent a credit crunch.

(Reporting by John O'Donnell and Francesco Guarascio; additional reporting by Francesca Landini in Milan; editing by Ron Askew)

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