ECB sees rising bank losses in euro zone

Banks in the euro zone face much higher losses than previously thought, mainly from their exposure to Eastern Europe and commercial real estate, the European Central Bank said.

The updated loss estimates for all loans and securities, which the ECB put at €553 billion ($796.57 billion) for 2007 to 2010, highlight the fragility of the currency bloc’s recovery.

Much of the projected losses have already been absorbed, the ECB said in a report Friday on the financial system. Of the total €553 billion estimate, banks could face €187 billion in additional write-downs before 2011.

The estimate, which is €65 billion more than what the central bank forecast just six months ago, suggests credit constraints across much of Europe won’t ease anytime soon as banks in the 16-nation euro zone continue to deal with fallout from the financial crisis.

The revised figures put the ECB closer in line with the International Monetary Fund, which early this year projected a worse effect on banks.

A dearth of credit for households and businesses could undermine the region’s recovery prospects by keeping a lid on spending, which is the main source of economic activity in the region. That should keep ECB interest rates at record-low levels well into next year, economists said.

“The road ahead is likely to be uneven,” despite a moderate economic recovery, ECB Vice President Lucas Papademos said at a news conference, noting that conditions at euro-zone banks have improved in the past three quarters and overall risk in the financial system has abated.

The ECB said the change reflects higher losses on commercial real-estate loans and banks’ exposure to securities issued in Central and Eastern Europe, which weren’t fully incorporated in prior estimates.

ECB officials received a stark reminder this week of the risks posed by that region when Austria nationalized one of its largest banks, Hypo Group Alpe Adria, at the behest of ECB President Jean-Claude Trichet. A number of euro-zone banks, including nearly all in Austria and Italy’s UniCredit, expanded into Eastern Europe in the past decade. Loan and currency losses have sharply eroded the value of those investments.

Economists say they worry about whether banks in Austria and elsewhere in Europe can provide the credit needed to spur spending by consumers and businesses and propel the recovery into 2010. The euro zone expanded modestly last quarter, breaking a string of five consecutive periods of declining output.

The ECB report also cited the potential for higher government-bond issuance as a risk to the financial system. Greece’s bond market was rocked recently when Standard & Poor’s became the second ratings firm in a week to downgrade the country’s sovereign debt to BBB+. Investors are bracing for a downgrade in weeks ahead from the only major rating company to still rate Greece above A: Moody’s Investors Service.

Greece’s deficit accounts for almost 13% of its gross domestic product. Ratings firms and investors question whether the new Socialist government can take the painful steps needed to bring the gap within European budget rules over the next few years.

Mr. Papademos, a former head of Greece’s central bank, called on the government to take “decisive” steps.

(Source: The WSJ)

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