Dexia rescue underlines fears for EU banks

A potential €200bn (£175bn) recapitalisation of the European banking sector loomed yesterday after the French and Belgian governments unveiled a rescue package for Dexia to stop the bank's woes from contaminating the wider financial system.

The planned boost to banks' capital reserves will see national governments in line to inject new cash if the lenders cannot raise the money in the market.

The urgency of increasing eurozone banks' buffers against losses was heightened by the near-failure of Dexia, the French-Belgian bank with big exposures to debt issues by Greece and other financially stretched countries.

The deal to bail out Dexia wasdesigned to stop the bank's crisis spilling out into the rest of the banking sector. The fates of troubled eurozone countries and the region's banks are intertwined and threaten a vicious spiral of losses.

European leaders yesterday delayed by a week a meeting scheduled for next Monday to leave time to receive a definitive report on Greece's fiscal crisis.

Belgium will pay the Dexia Group €4bn for the Belgian retail banking business and provide 60 per cent of state guarantees for a "bad bank" to house Dexia's troubled assets. France will provide 36 per cent of the guarantees, which cover up to €90bn of funding, with Luxembourg supplying the rest.

Dexia's balance sheet of €518bn is bigger than the entire Greek banking sector and is a similar size to the total assets of institutions rescued in Ireland. The bank passed European "stress tests" in July that were meant to shore up confidence in the banking sector.

France and Germany have agreed that Europe's banks should be made to raise extra capital to cushion the impact of a Greek default. The International Monetary Fund has calculated that the region's banks need up to €200bn extra to withstand losses.