European leaders inched closer Monday to an agreement that could avoid a potentially catastrophic default by Greece on billions of dollars in debt, as France proposed a plan that could serve as a model for other European lenders to the teetering nation.
With investor pressure mounting ahead of a crucial austerity vote by the Greek Parliament this week, President Nicolas Sarkozy outlined a proposal under which French banks would give Athens more time to pay back loans as they come due over the next three years.
The banks would share part of the cost of the bailout by extending new loans to Athens as old loans mature, but the banks would not have to forgive the debt itself, a concern of many investors.
“We’ve been working on this with the banks and insurance companies,” Mr. Sarkozy said at a news conference in Paris. “We’re committed to going from a principle — the voluntary participation of the private sector — to concrete reality.” Mr. Sarkozy said he hoped that other European countries would adopt a similar plan.
It comes at a critical moment in the long-running drama over how to prevent a default on Greece’s $467 billion debt.
A vote on Greece’s latest $40 billion austerity package is scheduled for Wednesday, with another vote scheduled for Thursday on separate legislation to carry out the reforms. If the measures pass, the European Union is expected to announce the size and details of a new, second bailout package at a meeting of ministers on Sunday.
If the Greek Parliament were to vote the package down, a chain reaction could engulf global financial institutions.
Investor confidence in the debt of countries on the periphery of Europe like Greece, as well as Portugal and Ireland, has been rapidly eroding. European financial institutions hold more than half a trillion dollars worth of their sovereign debt. Private borrowers in these countries, who would also be hammered by a public default, owe Europe’s banks another trillion, according to the Bank for International Settlements.
The French banks’ willingness to chip in underscores just how vulnerable giants like Société Générale and BNP Paribas would be in a full-scale default, a danger also confronting large institutions in Germany, Belgium and elsewhere. It is also why European leaders have the leverage to extract concessions from banks as part of a broader rescue package for Greece.
With European leaders unable to come up with a concrete plan until now and Greek politicians balking at calls for austerity, the picture for Europe’s banks has been growing dimmer by the week. “Investors think policy makers are kicking the can down the road,” said Philip Finch, a bank analyst with UBS in London.
As a result European bank shares have fallen nearly 25 percent over the last four months, helping bring down the shares of their counterparts in the United States, which have lost 13 percent over the same period.
But unlike American banks, which raised capital and wrote off tens of billions of dollars in bad loans after the financial crisis, European institutions have been much slower to acknowledge the problems they face, analysts and investors said. Even without a sovereign debt default, Mr. Finch said, European banks need to raise $150 billion in capital to bolster balance sheets.
French officials said the proposal announced Monday was the fruit of recent meetings between the Élysée Palace, the French Treasury, the Bank of France and the French banking federation.
The initiative is likely to be supported by Jean-Claude Trichet, the departing president of the European Central Bank, who had stood against plans to automatically impose losses on the face value of Greek debt.
The French plan was presented separately for discussion at a meeting of Greece’s creditors convened Monday in Rome by the International Institute of Finance, which represents many of the largest global finance institutions, and the Italian Treasury.
Large French banks, including Société Générale and BNP Paribas, declined to comment on the announcement individually or through their national banking federation.
In addition to owning $2.5 billion worth of Greek bonds, Société Générale faces billions more in exposure from its majority stake in the General Bank of Greece, a prime reason Moody’s warned this month that it might downgrade the company’s debt. The rating agency issued a similar warning for BNP Paribas, which does not have a local subsidiary in Greece but does own roughly $5 billion in Greek debt.
The danger from Greece is hardly limited to France. Belgium’s Dexia has $3.5 billion in Greek debt. Germany’s Commerzbank has a $2.9 billion position. ING owns about $2.5 billion.
With a gross domestic product of $329 billion — a small fraction of California’s $1.9 trillion — Greece’s output its tiny. The worry is just how quickly the ripple effects of a default would be felt in other European capitals, as well as on Wall Street.
A default by Greece would immediately endanger bonds issued by Ireland and Portugal, which investors consider the next-weakest borrowers after Greece.
Three-year Portuguese and Irish bonds already yield more than 14 percent, while the rate on comparable Greek notes stands at nearly 27 percent, suggesting that a “haircut” has already been priced in for all three.
And while European banks are owed $136.3 billion by the Greek government and private borrowers, according to the Bank for International Settlements, that jumps to $194.6 billion for Portugal and $377.6 billion in the case of Ireland.
Portugal alone owes French banks $27 billion, according to the BIS data, while Ireland owes nearly $30 billion.
“The concern is the spillover effect,” said Kian Abouhossein, who heads JPMorgan Chase’s European bank research team. “European banks are in a tougher position than those in the U.S.”
Besides the risk from a Greek default or the spread of contagion, European banks are also heavily reliant on short-term borrowing, which is riskier and more expensive in a crisis like the one after Lehman’s collapse, Mr. Finch and Mr. Abouhossein said.
With smaller deposit bases than American institutions, European banks have a loan-to-deposit ratio of 130 percent, compared with 80 percent in the United States.
American banks can finance their lending with deposits and have a cushion, but European institutions must turn elsewhere to finance their loans, borrowing heavily from United States money-market funds.
To make matters worse, the stress tests applied to European banks by regulators last year were less stringent than those in the United States, so while data from another batch of tests is due in mid-July, it is not expected to calm nerves significantly.
While they may not be on the front line, American banks do face serious risks in the event of a European meltdown, too.
Direct exposure to Greece is small in most cases — $677 million in the case of Bank of America, for example. But the indirect exposure is much harder to determine. American institutions have insured at least $5 billion worth of Greek debt in the event of a default through credit default swaps and could be on the hook for billions more from countries like Ireland and Portugal.
Some American institutions have made it clear they are cutting their exposure as quickly as they can. This month, the chief executive of JPMorgan Chase, Jamie Dimon, said his institution’s direct exposure to Greece, Portugal, Ireland, Spain and Italy had dropped from $20 billion at the end of the first quarter to $15 billion or less now.
“At the end of the day, they’re eventually all interlinked on some level,” said Glenn Schorr, a bank analyst with Nomura.