News and Finance

Euro-region banks may have to write down an additional 187 billion euros ($268 billion) as loans to property companies and eastern European nations threaten the recovery in financial markets, the European Central Bank said.

The ECB raised its estimate for writedowns for the period of 2007 through 2010 by 13 percent to 553 billion euros from 488 billion euros forecast in June. The ECB, which published its Financial Stability Review today, also said that “the surge in government indebtedness” around the world is a risk to financial stability and that some European banks are still reliant on emergency funding.

“An important reason behind the rise is the further deterioration in commercial property-market conditions,” the report said. “This has contributed to an upward revision in to the estimate of potential writedowns on bank’s exposures to commercial property mortgages and commercial mortgage-backed securities.”

Policy makers are trying to gauge the health of the financial system to better time the withdrawal of emergency measures without unsettling markets. While Deutsche Bank AG and Credit Suisse Group are among banks reporting rising earnings, financial institutions worldwide are rebuilding balance sheets after writing down $1.7 trillion since the U.S. property slump sparked a global crisis.

Bank Shares

The 64-member Bloomberg European Banks Index traded down 1 percent at 2:42 p.m. London time. The euro was little changed at $1.4342.

U.S. commercial real estate prices have plunged about 40 percent since October 2007, according to the Moody’s/REAL Commercial Property Price Indices. The ECB said that risks to banks include the “concentrations of lending exposures” to “central bank and eastern European countries.” It didn’t identify any specific nations.

Banks must improve their quality of capital, increasing the amount of equity and retained earnings they hold, by the end of 2012 to be able to withstand losses better, the Basel Committee on Banking Supervision said yesterday.

“The remaining losses will have to be buffered with banks’ core earnings over a relatively shorter period of time,” the ECB report said. About $1.5 trillion of capital has been raised by banks globally since the crisis started, according to Bloomberg data.

Government Support

As markets recover and growth resumes, the ECB has already said it will rein back its unlimited offerings of cash to banks next year poor credit personal loans. Vice President Lucas Papademos said at a press briefing today that conditions have improved “substantially in all funding sectors.” At the same time, some banks “remain reliant on temporary support measures extended by the Eurosystem and governments,” he said.

With the public finances of some eastern European countries under scrutiny, the ECB warned that banks should be wary of their loan exposure. The Austrian Central Bank on Dec. 14 said a stress test scenario over the next two years expects about 20 percent of loans at banking units in Eastern Europe to default.

“Overall I don’t think it’s a significant problem for the euro-area financial system but it could have important implications for certain banking groups,” Papademos said in an interview.

Exit Timing

European governments have spent $5.3 trillion shoring up banks since the collapse of Lehman Brothers Holdings Inc., according to European Union data. In addition to flooding banks with cash, the ECB has cut interest rates to a record low and started buying 60 billion euros worth of covered bonds.

Papademos today cautioned against “timing errors” in unwinding public support. “In particular, exit decisions by governments will need to carefully balance the risks of exiting too early against those of exiting to late.”

The report said pulling government support too early risks “triggering renewed financial system stresses.” Waiting too long “can entail the risk of distorting competition, creating moral hazard risks” and may exacerbate “risks for public finances,” the report said.

Papademos also urged the Greek government to take “substantial’ decisions to cut the European Union’s largest budget deficit and ease concerns about its fiscal health.

The ECB also considered a broader range of risks than in its June report, taking “better account” of collateralized debt obligations and residential mortgage-backed securities, it said.

There has also been “rising distress” in the European leveraged loan market since June, with increased loan defaults and restructurings, the report said.

Source