Eurozone debt could squeeze banks: experts

6th June 2010, Comments 0 comments

Eurozone banks could face a credit crunch as they compete with governments for funds in coming years, analysts and the European Central Bank say.

The ECB's Financial Stability Review said this week that banks must renew about 800 billion euros (950 billion dollars) in debt by the end of 2012, and that they would be competing head-on with governments in bond markets.

"In view of the considerable near-term funding needs of euro area governments, a particular concern is the risk of bank bond issuance being crowded out, making it challenging to roll over a sizeable amount of maturing bonds by the end of 2012," the central bank said last week.

That would in turn crimp bank lending to businesses and households, which has begun to recover and is needed to keep economies growing to replenish state finances.

Deficits and debt in many countries, which broadly were already at high levels, have shot up because of spending to overcome the global economic crisis to levels causing strains on bond markets.

Government debt in the 16-nation zone is forecast to reach 88.5 percent of gross domestic product in 2011, or roughly 8.3 trillion euros (10.0 trillion dollars).

Countries borrowed more than 800 billion euros in 2009 alone, partly to bail out banks, which in turn then bought public debt which had been driven up by the bail-outs.

"We should really take this seriously," ING senior economist Carsten Brzeski told AFP in a reference to the risk of public debt crowding out bank borrowing.

Asked if the process of banks buying public debt after being bailed out with state funds resembled the shady practice of using multiple bank accounts to cover rotating overdrafts, he said: "I think the parallel holds very well in terms of the inner eurozone circle."

He said that "pushing it from one to another and back is kind of a multiplier effect", and he noted that governments held underlying assets and their economies generated value that underpinned the process.

"It only works if the underlying fundamentals are healthy," Brzeski said.

"Otherwise it just goes up in smoke."

With the ECB now buying public debt from banks, IHS Global Insight economist Timo Klein added: "I don't think there is now at least any acute danger of some kind of market failure or seizure.

"The risks at the moment are moving away from the banks and towards the ECB."

Barclays Capital economist Thorsten Polleit told AFP: "One can imagine that central banks will not only provide bank refinancing in the money market but also for longer maturities (that is maturities beyond one year) in the future."

The ECB had hoped to withdraw from interbank markets as financing conditions normalised, but that plan was upset when investors began to worry that banks were exposed to big losses on debt from countries such as Greece, Portugal and Spain.

Commercial banks now "have to adapt to the new environment, reduce their dependence on wholesale finance and put aside significant reserves for loan losses," said economics professor Moritz Schularick from Berlin's Free University.

The ECB has warned that banks might have to write off 195 billion euros this year and next to reflect the diminished chances of full reimbursement on some loans, and US and British officials are pressing eurozone leaders for rigorous stress tests of banks.

Such tests aim to determine how a bank would fare if hit by a major event like a steep economic downturn or default by a major debtor.

In October, EU finance ministers unveiled results of tests of 22 eurozone banks but "they came out with very vague results," Brzeski said, in contrast with US tests credited with restoring confidence in big banks there.

On Wednesday, British Financial Secretary to the Treasury Mark Hoban said: "A genuine, rigorous stress testing exercise is urgently needed to answer questions around solvency in severe market conditions."

UniCredit chief economist Marco Annunziata noted that "lack of information is again playing a major role in undermining market sentiment, at least in Europe."

© 2010 AFP

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