Bank tests see debt at worst May levels - ECB's Paramo

SAN SEBASTIAN, Spain Fri Jul 23, 2010 4:41pm BST

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SAN SEBASTIAN, Spain (Reuters) - Stress tests on EU banks assume government debt prices fall back to the weakest levels they hit during the euro zone crisis and stay there, hurting bank loan books, an ECB policymaker said on Friday.

European Central Bank Executive Board member Jose Manuel Gonzalez-Paramo said the tests on the resilience of the region's banks, due to be published at 5 p.m. British time on Friday, submitted banks to "a hypothetical situation that is very improbable."

The tests assume "that spreads for public debt maintain at prices at the same levels at the beginning of May in the worst moment of the sovereign risk crisis," he said in a speech at a conference organised by Eurobask.

"Also, that the debt crisis is transmitted to the loan books of the banking system."

A rise in the premiums investors demand to hold sovereign debt can drive up commercial and consumer lending rates, increasing the chance of borrowers defaulting.

Gonzalez-Paramo, one of the European Central Bank's six-strong board, also confirmed the depth of economic downturn the tests would assume.

"In the case for the tests for the European banks, we suppose that accumulated growth for this year and next is 3 percent less than expected," he said.

"I have absolutely no doubt that the tests will be positive for the markets, for the supervisors and for the banks," Gonzalez-Paramo told reporters after his speech.

The region's sovereign debt crisis has calmed in recent weeks thanks to a string of emergency measures. Gonzalez-Paramo said the ECB's controversial bond buying programme, one of the key measures to settle bond markets, still had a use, despite purchases having come to a virtual standstill.

"We are very satisfied with the programme, and it is a programme that still has a job to do," he said.

The euro zone was highly unlikely to slide back into a recession although growth could slow in the second half of the year, he added. "The latest data shows the risk of a double-dip (return to recession) is minimal."

(Reporting by Paul Day, writing by Sakari Suoninen; Editing by Ruth Pitchford)

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