The European Central Bank says euro zone banks face another €195 billion in potential write-downs to the end of 2011 in a second wave of losses from the financial crisis.
In its latest Financial Stability Report, the ECB said public finances posed the biggest threat to the region's financial steadiness as high debt and deficits continue to unsettle investors. It also said floods of new government bonds could hamper companies' and banks' access to market funding.
The ECB estimates banks will need to make provision for further losses of €90 billion in 2010 and €105 billion in 2011, the first time it has given an estimate for next year. This comes on top of the estimated €238 billion already written down to cover bad loans by the end of 2009.
But higher loan writedowns were offset by a better outlook for traded assets, with some banks likely to see write-backs of as much as €32 billion.
The ECB said heavy issuance of government bonds was not just a problem in terms of potentially crowding out other investors, but could put upward pressure on bond yields in the US. An abrupt increase in US long-term bond yields could cause the cost of capital to increase and move investor sentiment away from the US, triggering a flurry of market moves, and possible leaving banks and other investors exposed to huge losses.
The ECB report said that, in the euro zone, low official interest rates were helping households to service loans but there was a risk of future house price falls and rate risks might also be rising.
Central bankers differ on bond buys
The European Central Bank has sent mixed messages on its switch of policy to buy government bonds, with bank president Jean-Claude Trichet defending the purchases and the German central bank chief criticising them.
Trichet told a conference organised by the Austrian central bank in Vienna that it did not undermine the ECB's policy or independence. 'We are not printing money,' he declared. 'The latest measures address a malfunctioning of certain market segments,' he added.
The ECB has come under fire for its unprecedented scheme of intervening in securities markets to buy government and private debt in a moved aimed at halting speculative attacks in the euro zone and restoring stability to bond markets.
Speaking in Mainz, Germany, German central bank governor Axel Weber, a key member of the ECB governing council, reiterated his criticism of the ECB programme to buy sovereign bonds.
'Monetary policy has taken new paths to fight the crisis that I continue to view critically,' said Weber, an unofficial candidate to become the next ECB chief in late 2011. Weber voted against the bonds measure and has spent considerable time since explaining his position.
The German central bank governor said he was concerned above all about the ECB's independence from political pressure.
Some analysts have argued that the ECB risks turning into a 'bad bank' if it keeps buying government bonds from troubled euro zone countries. The term 'bad bank' refers to a financial structure created to unload risky debt so commercial banks can get their finances in order.
Trichet wants euro zone budget monitor
European Central Bank president Jean-Claude Trichet called in an interview today for a euro zone fiscal union to monitor public finances, saying France, Germany and Italy had set 'very bad' examples.
Trichet told French daily Le Monde that supervision of fiscal policies, development of competitive economies and structural reforms in the euro zone needed to be 'radically improved'.
'We are a monetary union. We now need the equivalent of a fiscal union in terms of monitoring and supervising the implementation of policies on public finances,'he said.
The ECB chief added that close mutual surveillance as foreseen in the European Union's Stability and Growth Pact 'has been terribly neglected.' He said the likes of Germany, France and Italy had 'set a very bad example' also in terms of managing their own fiscal policy.
The European Commission has proposed that euro zone countries submit their budgets for peer review before presenting them for approval by national parliaments, provoking resistance which Trichet said he did not understand.
'I support the commission's proposal, which I consider to be perfectly aligned with the goal of improving governance in the euro area,' he said.
Trichet also supported plans by European governments to cut spending and raise tax revenues which have been criticised by some economists as potentially harmful to economic growth.
'What you call austerity plans I call plans for a progressive return to a sound fiscal situation,' the ECB chief said. 'In any case these wise policies are favourable to growth since they increase the confidence of households, businesses and investors,' he added.
