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Thursday, 18 June 2009

The worst is yet to come: Financial Crisis Part II

European banks: $283B more in writedownsFRANKFURT (Reuters) -- Euro-zone banks will probably need to write down another $283 billion this year and next on bad loans and securities, the European Central Bank said on Monday. The ECB estimated bank writedowns due to securities -- or toxic assets -- would total around $218 billion from the start of the financial turmoil to the end of 2010, while bad loans would account for another $431 billion -- a total of $649 billion, with an estimated $366 billion already announced. The figures were published in the ECB's latest Financial Stability Review, which concluded that risks to the financial sector had increased in the last six months amidst a deterioration in the economic environment which is putting pressure on the bottom line of companies and households.

"The contraction of economic activity and the diminished growth prospects have resulted in a further erosion of the market values of a broad range of assets," the report said. "Connected with this, there has been a significant increase in the range of estimates of potential future writedowns and losses that banks will have to absorb before the credit cycle reaches a trough." The ECB's estimate of $649 billion for the whole period contrasts with a figure of $904 billion from the International Monetary Fund in April.

The ECB said the calculations were surrounded by a high degree of uncertainty stemming from the economic and market outlook, accounting rules allowing banks to delay reporting writedowns and the very uncertain outlook for bank profits. "Against this background, write-off rates could increase by more than currently anticipated," the ECB said. However, ECB Vice-President Lucas Papademos said most big euro area banks "appear to be well-capitalized enough to withstand downside scenarios."

The report outlined a wide range of risks and dangers for the financial sector in the 16-nation region, ranging from the financial situation of firms and households to continued volatility on markets. "Both policymakers and market participants will have to be very alert in the period ahead. There is no room for complacency," ECB Vice-President Lucas Papademos told a news conference. Property prices could be expected to fall further, in some countries at least, and big banks and insurance firms remained vulnerable to a further erosion of the capital base and a loss of investor confidence.

Worse than expected?

The euro area economic downturn could be worse than currently expected and there were increasing signs of a negative feedback loop between the real economy and the financial sector -- although there were also some positives. "Following a weak start in 2009, there have recently been increasing signs from survey data -- both within and outside the euro area -- suggesting that the pace of deterioration in activity is moderating and that consumer and business sentiment is improving, although still remaining at low levels," the report said.

The ECB said the risk of deflation was limited and central bank actions in cutting interest rates and lending banks unlimited funds had helped reduce money market spreads, although these were still elevated for longer maturities. Without commenting directly on the outlook for official interest rates - now at a record low 1% -- the ECB noted households were in a better position to repay debt than earlier. "The interest rate risk faced by households has declined somewhat since (December 2008), and is expected to remain subdued looking forward," it said.

The ECB said the outlook for euro zone government bond yields was surrounded by persistent uncertainty regarding macro-financial developments. "Upward risks for yields could be seen if flight-to-safety flows unwind further or if bond markets have difficulty in absorbing the increased issuance needs of euro area governments," the report said.

As part of its measures to stimulate the eurozone economy, the ECB has been offering unlimited liquidity to banks, and will shortly launch longer-term refinancing operations. However, a debate has begun amongst policymakers about when such extraordinary policy measures need to be unwound. "The current ample liquidity provided by the ECB will not remain in place (forever)," Papademos said. Asked about the ECB's 12-month refi operations which will begin next week, Papademos said he would wait to see the market's reaction. "Then we will see what demand is from institutions ... at this point I will not speculate."

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