Saving Europe's Banks: Can the Dexia Deal Stop the Fear?

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Yves Herman / Reuters

A man walks past the headquarters of Dexia bank in Brussels on Oct. 10, 2011

It felt like déjà vu on Monday morning as France, Belgium and Luxembourg announced plans to rescue the embattled bank Dexia. Just as Dexia was set to become the first European bank to fall victim to the euro-zone debt crisis, the Belgian government stepped in to buy its retail operations for $5.4 billion as part of a wider bailout of the lender. At the same time, two French financial firms will take over Dexia's economically important business providing financing to municipal government.

The deal was announced after weekend talks between Dexia officials and the French, Belgian and Luxembourg governments, all of which already have stakes in the bank. The three countries said they would also provide a total of $122 billion worth of guarantees for the bank over a period of ten years. Dexia itself will create a "bad bank" into which some of its toxic assets will be transferred.

But if there is something familiar about the deal, that's because it repeats a scenario that played out at the end of 2008, when the financial crisis was already prompting bank bailouts elsewhere in Europe. That was when Belgium and France first intervened and became part owners of Dexia with their $8.1 billion bailout, while promising to ensure that none of the bank's depositors would lose money. Now with a second rescue necessary, Dexia symbolizes both the gravity of the current euro crisis and the challenge facing policymakers as they endeavor to staunch the bleeding.

Dexia was supposed to be one of European banking's brighter spots. Created in 1996 from the merger of France and Belgium's biggest municipal lenders, it grew into one of the world's largest public-finance banks, lending to local governments from the U.S. to Europe to Japan. Between 2005 and '06, it jumped from the 291th to the 55th place in the Forbes Global 500 index. It currently has a portfolio of loans and bonds of around $788 billon, many times the size of its relatively small customer-deposit base, and twice the gross domestic product of Greece. But the sharp downturn in the bank's fortunes — in 2008 and more recently — is the latest warning sign over the wider health of Europe's lenders.

So how vulnerable are European banks? There is an emerging acceptance that governments need to recapitalize the entire European banking system, which has failed to bolster its core assets since 2008 in the same way that U.S. banks have. Last week, the International Monetary Fund (IMF) increased the pressure on the E.U. to address the problem, estimating that the euro zone needs a rapid bank recapitalization of $270-$400 billion. "There is a general consensus that this is urgent, and should be done in the next few weeks," said António Borges, the IMF's Europe director, after meeting officials in Brussels last Thursday.

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