Trichet Says Risk Signals Are Flashing Red as Debt Crisis Threatens Banks

By Jeff Black and Gabi Thesing

European Central Bank President Jean-Claude Trichet said risk signals for financial stability in the euro area are flashing “red” as the debt crisis threatens to infect banks.

“On a personal basis I would say ‘yes, it is red’,” Trichet said late yesterday in Frankfurt after a meeting of the European Systemic Risk Board, referring to the group’s planned “dashboard” to monitor risks. “The message of the board is that” the link between debt problems and banks “is the most serious threat to financial stability in the European Union.”

Trichet, who chairs the ESRB, made the remarks as European leaders meet in Brussels to discuss how to stave off a Greek default, while preparing a second bailout. The EU is trying to avoid a repeat of the financial crisis that followed the 2008 collapse of Lehman Brothers Holdings Inc. (LEHMQ) and resulted in European governments setting aside more than $5 trillion to support banks.

The yield difference, or spread, between 10-year German bunds and Greek securities of a similar maturity was at 1,388 basis points today, up from 1,317 at the beginning of the month. Swaps on Greece rose 25 basis points to 2,012, signalling an 82 percent chance of default within five years, according to CMA.

‘Moral Support’

Greek bonds have been pushed lower as authorities bickered over ways to support the nation. The ECB and the German government have clashed over how much investors should contribute to alleviating Greece’s debt load, which reached 143 percent of gross domestic product in 2010. The German government has argued for an extension of the maturities of Greek bonds, with the ECB saying it opposes anything that could be interpreted as a default.

While Greek Prime Minister George Papandreou earlier this week won a vote of confidence, bolstering his new government’s chances of pushing through austerity measures to secure further financial aid, European finance ministers said earlier this week they would hold off on approving a 12 billion-euro ($17 billion) payment to the country promised for July until passage of the plans to cut the budget deficit and sell state assets.

“European leaders will try and convince Greeks and financial markets when they meet in Brussels today and tomorrow that they have a workable plan to help Athens avoid a debt default,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin. They’ll use a “mixture of arm-twisting and moral support” to force Greece to adopt further reform.

‘Serious Threat’

Federal Reserve Chairman Ben S. Bernanke downplayed the risk of a Greek default on U.S. banks, telling reporters yesterday that the impact would be “very small.” With “very few exceptions, the money-market mutual funds don’t have much direct exposure to the three peripheral countries which are currently dealing with debt problems,” he said.

The top U.S. prime money-market funds have about half their assets in securities issued by European banks, Fitch Ratings said in a report on June 21. The Bank for International Settlements estimated European lenders held $136.2 billion in loans to Greece at the end of 2010 and almost $2 trillion in Portugal, Ireland, Spain and Italy. Greece, Ireland and Portugal all received external support.

BNP Paribas (BNP) SA, France’s biggest bank, and rivals Societe Generale (GLE) SA and Credit Agricole SA (ACA) may have their credit ratings cut by Moody’s Investors Service because of their Greek investments, the ratings company said on June 15. German banks could also be at risk from contagion, Fitch said last month.

“The most serious threat to financial stability in the EU stems from the interplay between the vulnerabilities of public finances in certain EU member states and the banking system,” Trichet said. There are “potential contagion effects across the union and beyond.”

Basel Meeting

Part of a wider regulatory overhaul, the 65-member ESRB aims to identify and warn of brewing risks in the financial system. Trichet and Bank of England Governor Mervyn King, vice- chairman of the board, highlighted risks in areas including asset-price imbalances and exchange-traded funds.

King is also at the center of a regulatory overhaul in the U.K. and will hold a press conference in London tomorrow on Britain’s Financial Policy Committee. He said the ESRB meeting highlighted “the ability of banks to reduce maturity and, where relevant, currency mismatches in their funding structures and to absorb losses arising out of the ongoing credit cycle.”

The Frankfurt-based body can pass on matters to the heads of European governments if its warnings aren’t heeded. While the body will monitor macro-prudential risks, it may turn its attention to single institutions deemed systemically important.

The ESRB is one of four bodies in Europe’s financial regulation architecture. The others are the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority. 

The Basel Committee on Banking Supervision meets in Basel, Switzerland, today to discuss how much extra capital the world’s largest and most systemically important banks will be forced to hold to avert another financial crisis. Global central bank governors are scheduled to meet under the auspices of the BIS in Basel from June 25.

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