Spotlight on bank tests as ECB readies rate meeting

The European Central Bank on Thursday will urge eurozone banks and governments to shore up their accounts in the face of market pressure for a clear reading on the health of the European financial sector.

The ECB's main interest rate will undoubtedly remain at a record low 1.0 per cent set in May 2009 and bank president Jean-Claude Trichet will press banks again to draw on state support if necessary to bolster balance sheets.

Around 100 banks across Europe are being subjected to "stress tests" aimed at determining whether they can withstand shocks such as another recession or the default of a major borrower.

Economic activity has begun to ease in many European countries and government debt in those on the eurozone's rim poses a particular threat to growth, RBS analysts warned last week.

"Absent an effective policy intervention to tackle the debt crisis in the periphery over the coming months, the European economy will double dip in 2011," they said in reference to a possible second contraction.

Commerzbank chief economist Joerg Kraemer said Trichet would "demand that progress be made in budget consolidation and surveillance" by eurozone members.

In Switzerland, the Bank for International Settlements has warned that economic recovery could falter if governments did not wind down crisis stimulus programmes.

The global central bank body called for "immediate" steps to cut budget deficits and debt accumulation in "several industrial countries."

While Italian bank UniCredit pointed to "a low risk of double-dip recession," chief economist Marco Annunziata expressed the frustration of many peers over the financial sector's persistently worrying health.

"It is extremely lamentable that three years into the financial crisis, and with economies now in a recovery phase, the European financial system should still be experiencing acute difficulties, with parts of the banking system which seem to be terminally addicted to ECB support," he said.

The central bank called in one-year loans worth 442 billion euros ($557 billion) from more than 1,000 eurozone commercial banks last week, but also doled out around 250 billion to more than 170 banks.

Analysts say many of the latter probably cannot get loans at cheaper rates from peers on interbank markets owing to fears about exposure to heavy losses that the stress tests are meant to clarify.

"At the moment we are really lacking information about the health of the banking sector," Ernst and Young senior economist Marie Diron told AFP.

Attention is focused on banks in countries like Germany, Greece, Ireland, Portugal and Spain, but severe problems could spread much wider Diron warned.

"Given all the cross-holdings, if Spanish banks are really in deep trouble there will be repercussions across the eurozone," she said.

German central bank chief Axel Weber warned governments to be ready to help banks that reveal serious problems, and many experts forecast a painful round of restructuring ahead.

"A major improvement in transparency should be quickly followed up with recapitalisation or resolution of the weaker institutions," Annunziata said.

The stress tests are being managed by the London-based Committee of European Banking Supervisors in close cooperation with national bank regulators, with results expected in mid July.

With inflation well contained, the ECB should keep its main interest rate unchanged until well into 2011.