In Europe, a Conflict Over Bank Capital LONDON - Europe's banks and regulators are at odds about how financial institutions should increase their capital reserves. Authorities want European banks to tap existing shareholders and reduce employee bonuses to find a combined $147 billion to increase their core Tier 1 ratios, a measure of a firm's ability to weather financial shocks, to 9 percent by June. Citigroup estimates that Europe's financial institutions, minus the Greek banks, had raised at least 40 billion euros, or $51 billion, as of the fourth quarter of 2011. Banks, however, would prefer to sell or write down unprofitable operations, as well as adjust their balance sheets, to free up cash to meet the new requirements. One solution could be to increase capital reserves through rights offerings, which allow existing shareholders to buy new stock at a discount. But volatility in the financial markets amid Europe's sovereign debt crisis has damped investor interest. Many banks are waiting on the outcome of the Italian bank UniCredit's 7.5 billion euro rights issue, which closes at the end of this week. After initial investor skepticism, market participants say the Milan-based bank, which must raise almost 8 billion euros by June, is now expected to gain shareholder backing for the multibillion-euro capital increase. "Everyone is looking at the UniCredit deal as a litmus test for future capital raisings," said a senior investment banker from a leading bank in Europe, who spoke on the condition of anonymity because he was not authorized to talk publicly. If other options are not attractive, some banks may eventually turn to local governments for a helping hand. Last year, the European Union created the European Financial Stability Facility, a 440 billion euro fund that can be used to shore up firms" capital reserves. Banks will soon find out what regulators think of their plans. Financial institutions, including Deutsche Bank of Germany and BNP Paribas of France, had to submit their recapitalization strategies to national regulators by Friday. The European Banking Authority will review the plans in early February, and regulators have the power to veto any capital-raising plan they don't agree with. Much of Europe is expected to enter recession this year, so authorities are likely to reject capital-raising efforts, like cutting lending to businesses, that reduce support for the European economy. The banking authority has called on banks to raise the money through cuts in shareholder dividends and issuance of new stock. It has warned that the sale of any operation, particularly in banks" home markets, that hurts business lending won't be allowed. "Regulators are asking for the impossible," said Etay Katz, a banking regulatory partner at the law firm Allen & Overy in London. "They want banks to keep lending to the real economy, and there's an expectation banks will have to swallow the bitter pill of offering new equity at times when investors" appetite is negative." Nonetheless, some banks have been following authorities" demands. Société Générale must raise 2.1 billion euros, and announced last November it was slashing bonuses and scrapping its 2011 shareholder dividend to meet the new regulatory requirements. It also plans to cut almost 1,600 jobs in its investment bank unit and has offloaded billions of euros of sovereign bonds to reduce its exposure to euro zone debt. As of the end of September, Société Générale's core Tier 1 ratio stood at 9.5 percent. Not every European bank, however, can rely on its own earnings. Many midsize banks, especially in Southern Europe, face deteriorating local economic conditions and rising customer defaults. In Spain, for example, authorities say the ratio of bad loans to bank lending has hit a 17-year high. And the European Union expects the country's economy to grow a mere 0.7 percent this year, compared with 1.5 percent for the United States. "The outlook is mostly negative for banks in countries like Spain, Italy and Portugal," said James Longsdon, managing director in Fitch Ratings" financial institutions group, in London. Other banks are hoping the sale of so-called noncore assets in overseas markets will help to increase their capital reserves. The fire sale could be enormous. The European financial sector is expected to sell or write down more than $1.8 trillion in loan assets during the next decade, according to the consulting firm PricewaterhouseCoopers. That compares with just $97 billion from 2003 to 2010. Last week, the Royal Bank of Scotland, which already has met the European Banking Authority's capital requirements, sold its aircraft leasing business to a consortium of Japanese companies for $7.3 billion. Ireland's nationalized Anglo Irish Bank also has offloaded $3.3 billion in commercial real estate loans in the United States to Wells Fargo. In all, the Irish bank wants to cut nearly $10 billion in American loans as part of a government requirement to reduce its assets and trim its operations. Potential buyers, including American private equity firms, are lining up to take advantage, though analysts say the amount of assets up for sale will depress prices. That could reduce the impact on banks" capital reserves. Local European politicians also may block deals that they believe will hurt domestic consumers. "Banks may be restricted on deleveraging within Europe," said Simon McGeary, managing director for European new products at Citigroup in London. Banks also are restructuring their balance sheets to squeeze out extra capital. In a move known as liability management, banks can improve capital levels without raising additional funds. The strategy involves buying back or exchanging hybrid securities - investments that pay dividends like bonds, but can be converted into equity - at a discount from investors. Under accounting rules, financial institutions can then book the difference between the original face value of the securities and the current discounted price as a profit toward core Tier 1 equity. The strategy has been popular. Morgan Stanley estimates financial institutions, including Commerzbank of Germany and the Lloyds Banking Group of Britain, will raise a combined 8.7 billion euros by buying back, or exchanging, hybrid securities from investors. The adjusting of companies" balance sheets also includes so-called capital optimization, which involves tweaking banks" back-office systems to free up funds to meet the capital requirements. Credit Suisse estimates that Spanish banks, which must raise a combined 26.1 billion euros, could free up more than 3 billion euros by fine-tuning how they use capital without raising any new funds. "The only way for banks to succeed is to be more efficient with the limited capital available," said Steve Culp, global managing director of the risk management practice at the consulting firm Accenture in London. Banks, particularly in struggling southern European economies, may eventually have to turn to government bailouts. Deals already have been announced. In December, the National Bank of Greece and its local rival Piraeus Bank sold a combined 1.4 billion euros of shares to the government to increase their core Tier 1 ratios. "There's no magic bullet to this problem," said Karl Goggin, a banking analyst at NCB Stockbrokers in Dublin. The market has a finite appetite for banking stocks, so governments may have to step in.