The European Central Bank said Spain’s bailout will help to bolster financial stability in the euro area and governments must dispel investor doubts about the future of the monetary union at a summit later this month.
Euro-area aid of up to 100 billion euros ($125 billion) for Spain’s banks “will make an important contribution to ease existing banking vulnerabilities in the euro area,” the ECB said in its biannual Financial Stability Review published in Frankfurt today. “What we need besides this is to try to address the more encompassing doubts in the market about the future of the monetary union,” ECB Vice President Vitor Constancio said at a press briefing, adding this is a job for European Union leaders at a June 28-29 summit in Brussels.
Spanish bonds fell today, sending the 10-year yield to a euro-era record of 6.79 percent, after Fitch Ratings said the country will “significantly” miss its budget deficit targets and policy makers are failing to demonstrate they can bring the sovereign debt crisis under control. In its report, the ECB said the crisis remains the key risk to financial stability and “there is no room for complacency, either on the part of governments or on that of banks.”
While “the worst market manifestations of crisis may have passed, there remains a clear need for a continued focus on tackling its root causes,” the ECB said.
It identified three key risks to a stable financial system in the euro area: sovereign vulnerabilities, a risk to bank profitability stemming from weaker economic growth, and “excessive pace of deleveraging of the banking sector due to frontloaded changes to banks’ business models.”
The ECB estimates that banks will need to sell more than 1 trillion euros of assets over the medium term to bolster their balance sheets and increase resilience. On April 18, the International Monetary Fund predicted they could be forced to sell as much as $3.8 trillion of assets through 2013.
The ECB said that in contrast to the stresses seen at the end of last year, “concerns now appear to differ across entities depending on specific underlying fundamentals and have moved away from generalized self-fulfilling expectations that threatened an indiscriminate seizing up of liquidity with systemic consequences.”
Constancio said the ECB doesn’t expect Greece to leave the currency bloc and that it would be “impossible” to assess the ramifications of such an event in the financial stability review.
“We know that in the market, the probability has increased, and we recognize that, and the market has been reacting to that,” he said of a Greek euro exit.
The ECB report also backed European Commission proposals for a European banking union based on three pillars: Strengthening euro-area banking supervision, breaking the link between banks and sovereigns by establishing a European deposit guarantee program and “minimizing the risks for taxpayers through adequate contributions by the financial industry.”
Constancio said he doesn’t think a full fiscal union needs to be present before “some elements” of a banking union could be introduced.
“With the proper elements, you may not require significant amounts of public money for this to function,” he said. “I don’t see the necessity to have deeper fiscal union before entering into some elements of a banking union.”
Bundesbank Vice President Sabine Lautenschlaeger said in Frankfurt today that “to balance liability and control, the European level has to be given the appropriate powers of intervention. For this reason a banking union can only work if it is accompanied by a fiscal union.”
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