Eurozone warned against dallying on bank capital

European leaders risk inflaming a market panic if they capitulate to bank demands for more time to raise cash, according to warnings yesterday.

But policymakers face an acute dilemma ahead of a crucial summit on the sovereign debt crisis this weekend, because European banks are arguing there could be a new Continent-wide credit crunch if they are required to improve their capital positions over a short period of time. The speed as well as the scale of a bank recapitalisation plan is emerging as a key sticking point for negotiators.

A host of economic analysts warned yesterday that only a swift recapitalisation of European banks could ease the turmoil in the eurozone sovereign debt market, and that traders could violently reject anything that looks like a fudge. "Bank equity investors need an immediate capital injection," said Kian Abouhossein, of JP Morgan. "The discussed six to nine month timeframe is unacceptable."

Banking lobbyists, though, have launched an offensive in Brussels this week, arguing that if they are required to raise significant levels of new capital over a short period of time the consequence will be a Continent-wide credit crunch. Charles Dallara, managing director of the International Institute of Finance, the global banking lobby group, and Josef Ackermann, chief executive of Deutsche Bank, met the President of the European Council, Hermann Van Rompuy, and the head of the Eurogroup of finance ministers, Jean-Claude Juncker, for 40 minutes on Monday.

Mr Ackermann, warned last week that haircuts on sovereign debt combined with demands to boost capital could lead to a credit squeeze.

Banks have two ways that they can increase their capital levels. They can shrink their assets, which consist largely of loans to the real economy, or they can raise more equity. Mr Ackermann says that if higher capital ratios are imposed immediately, banks will attempt to meet their commitments by shrinking their assets, which would have a devastating effect on economic growth.