Markets tremble as ECB warns of further loan losses

The European Central Bank sent tremors through financial markets last night when it warned that banks in the eurozone nations faced having to write off another €195 billion in bad loans over the next 18 months. In what it predicted would be “a second wave” of loan losses, the ECB forecast a fresh flood of red ink for eurozone banks that already have written off €238 billion since the banking crisis erupted.

The ECB said that eurozone banks were facing a “hazardous contagion” from the government debt crisis. Banks hold hundreds of billions of euros- worth of bonds issued by eurozone member nations. Some of these have plunged in value amid growing doubts about the creditworthiness not only of Greece but also of Portugal and Spain, which was

The warnings were contained in the ECB’s latest Financial Stability Report, in which it predicted that eurozone banks would make loan losses of €90 billion this year and another €105 billion in 2011.

The ECB emphasised that most banks in the eurozone were now more resilient than in the past thanks to replenished capital levels, but they faced new sources of risk and questions over the sustainability of their profits.

The ECB also revealed that it had increased its purchases of eurozone government bonds, a measure introduced on May 3 at the height of concerns over Greece. It said it had settled €35 billion in bond purchases by May 28, up from €26.5 billion a week earlier.

In further evidence of the fragility in financial markets, the central bank also said it might delay the phasing out of cheap lending operations designed to help banks through the financial crisis. These were introduced when Lehman Brothers collapsed in September 2008.

The Spanish rescue last weekend of the provincial savings bank CajaSur reignited concerns about the strength of some continental banks. Over the weekend Caja Madrid, the country’s second-biggest savings bank, was revealed to be in emergency merger talks with five regional lenders.

Spain’s Socialist Government warned unions yesterday that it would take unilateral action on labour market reforms as the final deadline for the resolution of months of negotiations with unions and business leaders passed without agreement. It said that reforms would be imposed before the end of June.

The country is still reeling from last Friday’s decision by Fitch Ratings to downgrade the country’s sovereign debt from its AAA level, but a much-feared run on the euro failed to emerge in the first day of trading after the decision. The European currency edged ahead at first, recouping small losses incurred after the Fitch announcement, although trading was limited because of bank holidays in Britain and the United States and it ended little-changed against the dollar. However, analysts said that it remained vulnerable and that the heavy falls of last month could continue into June.