ECB warns of second wave of bank write-downs

The multitude of challenges facing the region's financial firms include a weakening commercial property market, hundreds of billions of euros in bad loans, economic problems in Eastern Europe, and potential competition between government and bank refinancing needs, says the report.

"We are experiencing now a second wave of writedowns, which relate to the performance of loans," ECB vice-president Lucas Papademos told reporters while presenting the review. "This is not unexpected. Although write-downs on loans will decline, they will continue, simply reflecting the overall performance of the economy."

"The overall resilience [of the financial sector] has increased, taking into account that capital buffers have been strengthened," he added. "But, at the same time, we are aware of the challenges ahead, particularly with respect to public finances."

Despite the measured statements from the outgoing ECB vice-president, analysts are growing increasingly concerned that eurozone government financing problems could lead to a second banking crisis in the region.

The recent bail-out agreements for Greece and other struggling eurozone administrations have failed to allay market fears that governments may be unable to deal with their rising debt levels.

The concern has led investors to punish European banks, conscious that they collectively hold hundreds of billions of euros of public and private debt in countries such as Greece, Spain and Portugal, with much of it linked to depreciating property markets.

The substantial stress in the sector has led banks to stash near-record amounts of deposits at the ECB instead of lending the funds to other institutions, while risk-wary US banks are reducing their exposure to their eurozone counterparts.

ECB squabbling

Last month's ECB decision to start buying eurozone sovereign debt from banks is among the initiatives aimed at unblocking the trade in government bonds, with the Financial Stability Review disclosing purchases of €35 billion to date.

But the internal friction caused by the bank's controversial decision was once-again on view on Monday as governing board members expressed their differing views in public.

ECB President Jean-Claude Trichet defended the bank's bond buying scheme, telling a conference in Vienna that it did not undermine the ECB's inflation-fighting policy or independent decision making.

"We are not printing money," said Mr Trichet, who has been as pains to stress that the additional liquidity created through bond purchases will be withdrawn in other areas.

Speaking in neighbouring Germany on the same day however, German central bank governor Axel Weber re-iterated his criticism of the ECB programme.

"Monetary policy has taken new paths to fight the crisis that I continue to view critically owing to the risks," said Mr Weber, who is seen as a strong contender to become the next ECB chief in late 2011 when Mr Trichet retires.