Europe's Banks Show Further Cracks

 By MATTHEW DALTON , STEPHEN FIDLER and LAURA STEVENS

Franco-Belgian bank Dexia SA agreed to be bailed out and broken up, becoming the first banking victim of the euro-zone sovereign-debt crisis, while further strains in Europe's banking sector emerged in Austria and Greece and governments continued to discuss a plan to revive confidence in their lenders.

Early Monday, Dexia's board approved a rescue plan drawn up over the weekend by the governments of France, Belgium and Luxembourg, under which the bank's Belgian unit will be nationalized and its other divisions sold. Dexia will receive up to €90 billion ($120 billion) in taxpayer guarantees, mainly from Belgium, to shore up its funding.

Meanwhile, Austrian bank Erste Group issued a surprising profit warning on Monday, cautioning that it expects a net loss of nearly €1 billion this year instead of a solid net profit, because of its exposure to the debts of struggling euro-zone governments as well as write-downs at its units in Hungary and Romania.

Erste's move raises the possibility that other euro-zone banks might decide to recognize deeper losses on their sovereign-debt holdings as they report earnings in coming weeks.

Greek bank shares fell sharply Monday as investors worried that a further bailout of the country will mean the lenders will face bigger write-downs on their holdings of government debt.

Many investors fear that Dexia won't be the last European bank to succumb to its heavy exposure to struggling euro-zone governments such as Greece. The deepening mistrust between Europe's banks is leaving many lenders dependent on emergency funding from the European Central Bank, and reviving memories of the aftermath of Lehman Brothers' collapse in 2008.

Amid mounting fears that the twin banking and government-debt crises could push Europe into recession and even undermine global growth, euro-zone leaders are working on a plan to recapitalize their banks and deal with Greece's unsustainable debts. The European Union said its next summit of leaders will take place on Oct. 23, a week later than planned, a move that officials said was needed to allow more time to negotiate the anti-crisis measures.
 
German Chancellor Angela Merkel and French President Nicolas Sarkozy promised on Sunday that they would present a "comprehensive package" to stem the crisis by late October, but gave no details. Berlin and Paris are trying to reconcile their differences over who should pay for banks' capital injections and Greece's funding needs.

The French and German leaders' promise to reach an accord and strengthen euro-zone banks was enough to lift many financial markets on Monday, including shares in Europe and the U.S.

Euro-zone officials say it's increasingly likely that holders of Greek government debt, many of which are European banks, will soon be forced to take larger losses than were envisaged under the deal agreed to by EU leaders only on July 21. Greece's finances have worsened since then, and as a consequence the deal offered to bondholders looks generous. The prospect of bigger Greek losses for banks is forcing governments to look into bolstering banks' capital reserves.

The European Banking Authority, the pan-European regulator set up at the start of the year, will make new assessments of banks' capital needs based on information disclosed by banks during stress tests carried out during the summer. The assessment is expected to include more negative scenarios for sovereign debt than did the summer tests.

Bank analysts said Dexia was especially vulnerable to a loss of confidence based on worries about its holdings of sovereign debts. It depended more heavily than any other euro-zone bank on skittish wholesale funding markets. However, other European banks, including French ones, are also facing funding pressure.

Under the Dexia bailout, engineered by the Belgian and French governments, no creditors or depositors stand to lose money.

However, underlining the risks of an interlocking bank and sovereign-debt crisis, Moody's Investors Service cited the government guarantees for Dexia as one reason for placing Belgium's Aa1 credit rating under review for a possible downgrade.

France is jealously protecting its top triple-A rating. French officials fear that rating firms could downgrade it if the country is forced to inject large amounts of money into its major banks.

At a news conference on Monday, Dexia's chief executive, Pierre Mariani, assigned part of the blame for his bank's crisis to European politicians, saying his institution had shown "naivete" by maintaining its exposure to Greece and other indebted euro members since last year at the behest of governments.

Belgium's government has agreed pay €4 billion to take over Dexia's operations in the country. Under the rescue plan, Dexia must sell off its much-coveted Turkish unit DenizBank, sell its Luxembourg unit to investors including Luxembourg's government, and unload its local public-finance unit to state-owned banks in France.

After being suspended on Thursday, trading in Dexia's shares reopened Monday afternoon, producing some wild price swings. Dexia's shares closed down 4.7% at 81 European cents after initially falling more than 30%.

Antoine Houssin, a bank analyst based in Paris at Natixis, said the rescue plan should help to lift some of the uncertainty that has troubled European financial markets, and that Dexia's problems were more acute than those of other lenders.

"When we look at the French banking sector, there is no other bank that is in the situation of Dexia," Mr. Houssin said. But Dexia's continued exposure to struggling euro-zone governments' debts remains a significant risk for its owners and creditors, he said.

The weekend bailout is the second time the three governments have had to step in to save the bank since the financial crisis started. In 2008, Belgium, France, Luxembourg and Belgian regional shareholders injected €6.4 billion of new capital into the bank in following the failure of Lehman Brothers bank.

Dexia, which was created in 1996 from the merger of Belgian and French government-lending banks, grew into one of the world's largest public-finance banks in 2008. The group lent to local governments stretching from the U.S. to Europe to Japan, amassing an enormous portfolio of loans and bonds that reached €650 billion in 2008. The bank mainly depended on funding from financial markets instead of more secure retail and commercial deposits.

Analysts said the biggest surprise in Erste's profit warning was that it booked a large one-time charge on its derivatives exposure to Southern European governments, writing down its credit-default swaps to market value at an overall loss of €450 million. This type of exposure to euro-zone sovereign debt wasn't required to be reported during Europe's stress tests. Erste said it has reduced its total net exposure to crisis-hit governments around the euro zone's periphery to €600 million, from €1.9 billion last year.

—Inti Landauro, Eyk Henning and Laurence Norman contributed to this article.wsj.com