Europe could face “unprecedented” finance risk in early 2012

December 19, 2011

European governments and banks will be competing to raise hundreds of billions of dollars from investors in the next few months, European Central Bank President Mario Draghi warned Monday, saying the financing squeeze could help push the region into a new recession.

Draghi said that governments and banks in the euro zone have about $500 billion in outstanding bonds coming due in the first three months of 2012. Many of these notes will have to be refinanced with new loans.

“The pressure that bond markets will be experiencing is really very, very significant, if not unprecedented,” Draghi said during a two-hour appearance before the European parliament. He highlighted the danger of banks slashing loans they make to businesses and families if stiff competition on the bond market makes it too expensive for the banks to raise the money they need from investors. Next year “is going to be a difficult year for the banks,” he said.

European banks already have been curtailing loans to businesses and individuals in response to the region’s debt crisis, contributing to a slowdown in the euro-area economy.

“Priority has to be given . . . to make sure we don’t have a recession coming from funding pressure,” Draghi said. He noted that many banks are not able to issue corporate bonds at affordable rates under current conditions, just as European governments have struggled to issue their bonds.

Draghi’s remarks, combined with the release of the ECB’s annual financial stability review, portray a region still unable to tackle its problems despite recent initiatives taken by the continent’s political leaders. Moves earlier this month toward closer budgetary cooperation among the 17 euro-zone nations was an important step, Draghi said, but will do little to relieve the risks of a near-term credit squeeze.

European leaders on Monday conferred by phone on one aspect of their crisis-fighting strategy: how to raise and use about $270 billion that euro-zone countries want to funnel through the International Monetary Fund. The amount was scaled back to roughly $200 billion after European nations outside the euro zone, most notably Britain, said they may not contribute.

In his first testimony to the European parliament since taking over from Jean-Claude Trichet two months ago, Draghi said the ECB decided last week to loosen its lending standards for financial firms in advance of the financing squeeze coming early next year. The ECB has agreed to let banks take out loans for as long as three years, giving them time to plan investments and pursue other business initiatives without worrying about whether their funding might dry up.

The first of those longer terms loans will be offered this week.

Draghi said the ECB loans could indirectly help some heavily indebted European countries if the banks use the ECB loans to invest in government bonds. Many European banks are now facing possible losses on their holdings of bonds issued by cash-strapped governments and don’t want to buy any more. But the banks might be willing to resume their purchases if they don’t have to repay their loans to the ECB for three years. By then, the region’s debt problems might be resolved and the governments restored to financial health, thus better able to honor their obligations.

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