The 15 euro zone countries remain at high risk of further market turmoil, the European Central Bank said today as it urged banks to take advantage of state aid offers to help the economy.
In its periodic Financial Stability Review, the ECB said the countries that use the euro currency were facing four main dangers. It warned of further deterioration in the US and euro zone housing markets and its potential impact on banks' loan quality and the value of securities backed by mortgage-related assets.
The ECB also saw the spectre of a 'deeper and more prolonged slowdown in both the global and the euro area economy than currently expected' which could hobble borrowers' ability to repay their debt.
In addition, stronger de-leveraging by banks could hit the flow of credit extended to the broader economy, creating funding gaps with potentially far-reaching consequences.
The ECB also said the euro zone needed to head off a surge in financial market volatility that would be caused by hedge funds as they reduce their risk exposure by unwinding potential commitments on financial markets.
'All in all, given the risks that lie ahead, banks will need to be especially watchful in ensuring that they have adequate capital and liquidity buffers in place to cushion the challenges ahead,' the ECB said.
It said extraordinary actions taken by central banks and governments to cope with the crisis had succeeded in stabilising the euro banking system for the time being.
'Over time, once fully implemented, these measures should lower the cost of bank credit and facilitate its provision to the economy,' it said. But banks must take the hand extended to them to avert further damage to the already battered economy, it added.
The euro zone economy contracted in the second and third quarters of 2008 in its first technical recession. The ECB has attempted to cope with the situation by cutting rates by an unprecedented three times in two months.
ECB president Jean-Claude Trichet said last week that the bank expected the euro zone economy to shrink by 0.5% next year and that the contraction could reach as much as 1%.
But sharp and repeated central bank cuts have failed to unlock the interbank lending crucial to business that ground to a halt after the US market for sub-prime mortgages collapsed in mid-2007.
