ECB: Sovereign debt still a risk to banks

City A.M. Reporter
The EU’s banking sector faces further setbacks before it recovers from the financial crisis, the European Central Bank (ECB) said in its annual report on banking stability yesterday.

The bank said there is still a risk that the Eurozone’s debt problems could again spill over into the financial sector, and that many institutions still rely too much on funding from the ECB.

“Risks to banking sector stability remain,” the ECB said in the report. “In particular, the risks increased in the early months of 2010 with a progressive intensification of market concerns about sovereign credit risk in some euro area countries.”

The ECB, headed by Jean-Claude Trichet, said that banks appeared to be over the worst of the required asset writedowns when the report was compiled in June, but that other pressures remained.

“While country-level information suggests the increase in non-performing loans is likely to be slowing down in many parts of the EU in 2010, the decrease in coverage ratios could put some upward pressure on provisioning costs,” it said.

It predicted that banks would have to bulk up key parts of their operations such as consumer lending and asset management to provide a steady source of longer-term funding. In contrast they may have to jettison more volatile parts that lack scale and security.

“Banks’ return on equity is likely to decrease under the influence of several drivers, especially given that banks are expected to continue to deleverage,” the report said.

On a brighter note it pointed to improving bank profits. “Profitability has improved slightly and could improve further over the next six months, giving firms the means to decrease their high indebtedness,” it said.