August 15, 2022

E.U. Vows to Back Banks That Fail Stress Tests

The results of the stress tests, which are scheduled to be released on Friday, could pose a headache for the 27 European Union finance ministers who met here to discuss ways to ease the region’s financial turmoil.

Olli Rehn, the European Union’s commissioner for economic and monetary affairs, said that once vulnerable banks were identified they “must recapitalize themselves, or be recapitalized or restructured.”

In a statement, the finance ministers said that backstop mechanisms would aid struggling banks.

“These measures privilege private sector solutions but also include a solid framework for the provision of government support in case of need, in line with state aid rules,” the statement said.

Officials insist that the exercise is more stringent than tests done last year, which failed to reveal a looming banking crisis in Ireland. The new tests will include a review of how lenders would handle a 0.5 percent economic contraction in the euro zone in 2011, a 15 percent drop in European stock markets and potential trading losses on sovereign debt.

The officials insist that Europe’s banks and governments are better prepared this time around.

Jacek Rostowski, the finance minister of Poland, which holds the European Union’s rotating presidency, argued that Europe now had “a banking system that is in much better shape than it was last year.”

A fresh example of the stress that banks will need to endure came late Tuesday. Moody’s Investors Service cut Ireland’s credit rating to junk status, adding it to Portugal and Greece on the list of euro area countries whose ratings are below investment grade.

Ireland’s rating was lowered to Ba1 from Baa3, and Moody’s signaled that the country faced further downgrades in the next year. Standard Poor’s and Fitch Ratings still have an investment grade rating for the country.

Moody’s said Ireland would most likely need another bailout and that policy makers would force the private sector to shoulder some of the burden.

“The prospect of any form of private sector participation in debt relief is negative for holders of distressed sovereign debt,” the company said in a statement. “This is a key factor in Moody’s ongoing assessment of debt-burdened euro area sovereigns.”

After the downgrade, the Irish agency that manages the country’s debt said that it had sufficient money from the country’s first bailout to cover its financing requirements until the end of 2013.

The downgrade of Ireland was certain to raise investor fears that the Greek debt crisis would spread. European officials raised the stakes on Tuesday by pressing for an emergency meeting of euro zone leaders on Friday, the same day that the stress test results are expected to be announced.

The plan represents a risky gamble by Herman Van Rompuy, the president of the European Council. If the meeting is held on schedule and fails to answer the crucial questions about Greece that were left unresolved by European finance ministers on Monday and Tuesday, it could end up unsettling the markets even more.

A gathering of finance ministers from the 17 countries that use the euro ended on Monday with a declaration suggesting that their bailout fund would be expanded and could be used to buy sovereign bonds from Greece and other deeply indebted countries.

That kind of declaration —rejected months ago because of German objections — has forced its way back onto the agenda because of the growing turmoil in the financial markets and fear that Spain and Italy could also be victims of Europe’s debt crisis.

As the meeting on Monday was getting under way, George A. Papandreou, the Greek prime minister, sent a letter to Jean-Claude Juncker, the prime minister of Luxembourg who leads the group of euro zone finance ministers. The letter was made public on Tuesday.

“If Europe does not make the right, collective, forceful decisions now,” he wrote, “we risk new, and possibly global, market calamities due to a contagion of doubt that could engulf our common union.”

“ ‘Crunch time’ has arrived,” he added, “and there is no room for indecisiveness and errors.”

Niki Kitsantonis contributed reporting from Athens.

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