Tags: Bailout, Banks, Central Banks, Debt Contagion, ECB, Europe, Eurozone, Global Investing, Jason Simpkins

Banks and Investors Both Rattled by European Debt Concerns

By , Money Morning •

European debt concerns continued to weigh on investor sentiment today (Thursday) as rumors circulated that the European Central Bank (ECB) was planning an intervention into the continent's banking sector.

The ECB is buying government bonds and increased its lending to banks, but that has done little to alleviate concern that the nearly-$1 trillion (750 billion euros) Eurozone bailout package announced last month won't be enough to prevent a collapse in the banking industry.

The ECB said on Monday that European banks will have to write off more loans this year than they did in 2009. The region's banks are expected to write off some $237 billion (195 billion euros) in bad debt by 2011.

"Although the profile of ECB estimates of the potential write-downs on loans confronting the euro area banking system displays a peak in 2010, it is probable that loan losses will remain considerable in 2011 as well," the central bank said. "This prospect, combined with continued market and supervisory authority pressure on banks to keep leverage under tight control, suggests that banking sector profitability is likely to remain moderate in the medium term."

Borrowing costs could rise as the banks compete with governments in the bond market, "making it challenging to roll over a sizable amount of maturing bonds by the end of 2012," the ECB said in its biannual Financial Stability Review.

Borrowing costs have already risen sharply in Europe, as banks have grown increasingly reluctant to lend to their peers. 

Data from the British Bankers' Association showed the three-month U.S. dollar London Interbank Offered Rate, or Libor, rose to 0.53781% today from 0.5375% yesterday (Wednesday).  Libor, which is the rate banks pay each other for three-month loans in dollars, is a liquidity indicator.

The rate rose to 0.53844% on May 27 - its highest level since July 6 of last year - on concern that banks owned too many bonds from Europe's most indebted nations.

Meanwhile, overnight deposits at the ECB rose to a record high yesterday. Banks left $394 billion (320.4 billion euros) in the ECB's overnight deposit facility at a rate of interest that's far lower than what they would receive lending to other banks.

'It's all part of concern about the system, about whether the sovereign-debt crisis will morph into a bigger systematic crisis,' Padhraic Garvey, head of investment-grade strategy at ING Groep NV (NYSE ADR: ING) in Amsterdam, told Bloomberg News. 'We're not quite at a point where that's imminent, but that risk is being priced in.'

Analysts continue to speculate on whether or not the ECB will step in to ease tensions among the region's banks.

"There has been speculation in the past day or so that the ECB is going to have to roll out some kind of debt guarantee program," Greg Woodard, portfolio strategist at Manning & Napier in Fairport, New York, told Bloomberg. "That signals to the markets that maybe the ECB knows something that the market doesn't, suggesting that conditions are worse than we know about."

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