By JACK EWING
Published: May 31, 2010
NY Times-FRANKFURT — Despite recent improvements in the health of European banks, they remain vulnerable to a daunting array of hazards that are expected to produce another round of sizable write-offs during the next couple of years, the European Central Bank said Monday, in a report that catalogued in alarming detail the problems facing the region’s financial institutions.
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Ewald Nowotny, left, the Austrian National Bank governor, with the European Central Bank president, Jean-Claude Trichet, before a conference in Vienna on Monday.
The challenges for banks in the euro zone include exposure to a weakening commercial real estate market, hundreds of billions of euros in bad debts, economic problems in East European countries, and a potential collision between the banks’ own substantial refinancing needs and government demand for additional loans, the E.C.B. said.
In its twice-yearly review of risks facing the 16-country euro zone, the E.C.B. expressed particular concern about banks’ need to refinance an estimated €800 billion, or $984 billion, in long-term debt by the end of 2012.
Borrowing costs could rise as the banks compete with governments in the bond market, “making it challenging to roll over a sizable amount of maturing bonds by the end of 2012,” the report said.
The increased demand for credit is likely to further strain banks as well as companies in need of credit. As it is, many European companies are suffering from low profitability as well as too much debt, the report said.
“The financial markets remain fragile and especially the developments in recent weeks have shown the necessity of heightened alertness,” Axel A. Weber, president of the Bundesbank and a member of the E.C.B.’s governing council, said Monday during a speech in Mainz, Germany.
Lucas D. Papademos, the departing vice president of the E.C.B., struck a more upbeat tone at a news conference Monday to present the so-called Financial Stability Review. While attempts by European governments to lower debt will cut demand, he said, growth could ultimately improve as economies became more productive.
“It is possible that the short-term impact will not be as severe as seems to be expected at the moment,” said Mr. Papademos, whose term ended Monday.
European banks will need to set aside an estimated €123 billion in 2010 for bad loans, and an additional €105 billion in 2011, the report said, in addition to the €238 billion they set aside from 2007 to 2009.
The sum for 2010, however, was lower than previous estimates. Banks also benefited from a rebound in securities markets, the report said.
While profitability of larger banks has improved, their shares are likely to fall in the near future, the E.C.B. said, citing an analysis of options that investors use to bet on the direction of stock prices.
The E.C.B. report also noted that some banks remained dependent on the central bank for loans.
Since the advent of the financial crisis, the E.C.B. has granted almost unlimited credit to banks at 1 percent interest to offset a reluctance by banks to lend to each other.
“The continued reliance of some smaller or medium-sized euro-area banks on central bank refinancing continues to be a cause for concern,” the report said.
Mr. Papademos said the number of banks involved was small, but he declined to give details. He also expressed concern about what he called “adverse feedback” between the sovereign debt crisis and the banking system. The E.C.B. report noted that higher risk premiums for government debt fed through into the private sector and raised the cost of credit for companies.
The problems would be exaggerated if growth or unemployment were worse than expected, increasing the chances that companies and individuals would be unable to repay their loans.
The report also noted that some financial markets were still not functioning normally. Issuance of corporate bonds has declined since the end of last year, especially for banks and other financial institutions. In addition, the market for securitizations, in which banks package loans and resell them to investors, is “dysfunctional,” the E.C.B. report said.
Bond issues and securitizations are crucial ways that banks raise money to loan to companies and individuals.
The report, as well as separate statements by E.C.B. officials Monday, also shed light on the central bank’s decision on May 10 to buy government and corporate bonds on open markets. In the days leading up to the decision, trading in some government debt had come nearly to a standstill, the report said. The lack of a market for government bonds endangered the functioning of the whole financial system, in part because banks typically use sovereign debt as collateral in making loans to each other.
“The tensions in the sovereign bond markets spilled over to other market segments, such as the foreign exchange market and equity markets,” the E.C.B. president, Jean-Claude Trichet, said during a speech Monday in Vienna. “Trading volumes and liquidity became erratic, and volatility spiked.
“In view of these exceptional circumstances prevailing in the financial markets, we decided that exceptional intervention was necessary,” he said.
Mr. Weber, in his speech Monday, repeated his criticism of the bond purchases and said that they would remain limited in scope. Some economists see the bond purchases as breaking a taboo and risking inflation, since they amount to the E.C.B. financing governments that have borrowed irresponsibly.
Mr. Trichet repeated that the central bank was “permanently alert and always prepared to act when necessary” in response to crises.
But he made clear that the E.C.B. could do only so much to restore stability to the financial system.
Euro-zone governments must ultimately create a system for disciplining countries that violate treaty limits on debt and deficits, he said.
“I call on euro-area governments in particular to work actively together to reach agreement on a quantum leap of the effectiveness of their collegial surveillance,” Mr. Trichet said.