The sovereign debt crisis has evolved into a crisis of confidence, with the French banks being served up as whipping boy, but they are certainly not going to be the last if left unchecked. In Europe, nearly all the major banks have large eurozone sovereign debt holdings. They also hold fewer deposits in relation to their outstanding loans compared with U.S. and Asian banks.
Barclays found that nine of the largest 14 European banks have illiquid net loans held for investment that exceeded the amount of deposits on hand, making them dependent on volatile funding from the capital markets. Société Générale had a loan-to-deposit ratio of around 130%, making it dangerously dependent on outside funding. But it was far from the worst offender in the group. Italian banks Intesa Sanpaolo, with 160%, and Unicredit, with a 149%, along with the UK's Lloyds, also with 149%, had worst ratios, equating to an absolute deficit of deposits to loans amounting to 139 billion euros, 185 billion euros and 214 billion euros, respectively.
In August, Christine Lagarde, the head of the International Monetary Fund and the former French finance minister, said in a speech at a banker conference this August in Wyoming that European banks were in need of "urgent recapitalization." "This is key to cutting the chains of contagion," she said.
It is unclear how much the funding shortfall is at this point. A leaked IMF report last week suggested that European banks would need around $275 billion. Money managers tell Fortune that their models suggest somewhere around $500 billion, which is derived by essentially adding up all the peripheral sovereign debt held by European banks. Whatever the number, it will need to be really big to bring confidence back. The Troubled Asset Relief Program (TARP), set up in 2008 to recapitalize the US banking sector, was $700 billion. In Europe, the European Financial Stability Facility (EFSF) will be 440 billion euros or around $600 billion, once its enlargement is ratified by the parliaments of all 17 members of the eurozone.
Now, the EFSF isn't exactly TARP, as its mandate is to recapitalize profligate governments, not banks. But once the nation receives the cash, they can then turn around and inject it into their troubled banks. So Greece could use the cash to pay its loans and fill its budget deficit while France could inject cash into Société Générale.
The fear is that the market is already pricing in passage of the EFSF. If so, then it is sending a clear signal to European finance ministers that $600 billion is not enough to restore confidence in the system. Treasury Secretary Timothy Geithner, one of the architects of the TARP program, is in Poland today attending an informal meeting of European finance ministers. He could be there to help the Europeans see the benefits of using the EFSF as a vehicle to restore confidence in the eurozone. If the fund is repackaged in that way, it may help to ease investor fears.
To be sure, a TARP-like EFSF will not solve the European sovereign debt crisis, just as TARP has done little to fix the U.S. housing crisis. The program will only serve to restore confidence in order to avoid a run on the banking sector and to give all parties some breathing room to get their houses in order. Eventually, real structural changes will need to take place to fix the troubles of the eurozone.
Europe has the opportunity to devise real structural changes to the eurozone that would prevent another sovereign debt crisis, namely the centralization of the zone's fiscal and monetary policy. It remains to be seen if there is strong enough will in the 17 capitals of the eurozone to take such a bold step. Failure to do so could put the continent right back where they started in just a couple years time.
