The European Banking Authority stress test earlier this December found that the Europe-wide capital deficit, which was thought to have improved, had actually worsened from €106bn to €115bn, prompting worry that the requirements are squeezing banks’ business instead of making them safer.

Big banks, such as Banco Santander, Société Générale, Paribas and CommerzBank have been selling assets at a torrid pace to fulfill the requirement of 9% deposit reserves in high-quality assets.

The EBA hoped banks would boost capital ratios by foregoing dividends and soliciting fresh contributions from shareholders. But banks are reluctant to slash dividends, which they see as a key attraction for investors, and with markets tumbling they have been buying back shares instead of issuing them.

Asset sales are an inevitable move but nonetheless a damaging one for banks. Take Banco Santander, which has to raise €15bn to reinforce its consolidated balance sheet – more than any other bank in Europe. In the last two months Santander has sold stakes in its Colombian, Chilean and Brazilian banks, as well as its Latin American insurance business.

The transactions are essentially a tradeoff of risk for future revenue. By shedding Latin American operations, Santander gives up both cash generation and high growth. Santander Chile, for example, had a return on equity (ROE) over the last 9 months of 24%, more than double that of its parents company. “They are selling the crown jewels,” an analyst for Barclays said in a Reuters interview.

The timing is not exactly opportune either. The Santander Chile sale valued the whole subsidiary at US $10bn, down from $13bn in the summer according to company financials. The Brazil unit’s stock was down more than 40% since its 52-week high at the time of sale, reported The Wall Street Journal.

Meanwhile, Santander is barely lending in Europe. This month it announced a €6bn small-business credit line in Andalucia, but only with the backing of a government underwriter.

There is another option. During the 2009 financial crisis, Ireland created a bad-debt bank to acquire property development loans from Irish banks in return for government bonds. The move is largely seen to have restored growth since Ireland’s 2009 bailout.

In Spain’s case, the bad-debt bank faces an enormous snag. Spanish banks are dealing with not only a property bubble (like Ireland in 2009), but also a crisis of confidence in the European sovereign debt they were encouraged to accumulate. This means that a swap for government debt is not a viable option. With Spanish government borrowing costs at barely tenable levels it’s unclear if the government would be able to fund the asset purchases with less risky instruments.

Regardless, big lenders like Santander have rejected the idea, reports the Financial Times, because they see an opportunity to absorb weaker, smaller banks that would be propped up by the proposed bad bank.

Germany does have the luxury of an Ireland-style bailout through government debt and has promised to do just that for its most troubled institution, Commerzbank, if the bank cannot meet the capital requirements on its own. The only potential problem is a moral one: the bank may not have enough incentive to act when it knows the government will step in if it does nothing. 



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