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EU warned of credit crunch threat, French banks hit

Sep 14, 2011, 11 a.m.
An employee enters the headquarters of French bank Societe Generale, the country's second largest, at La Defense, west of Paris, August 11, 2011. REUTERS/John Schults

By John O'Donnell and Lionel Laurent

WROCLAW,Poland/PARIS (Reuters) - European finance ministers have been warned confidentially of the danger of a renewed credit crunch as a "systemic" crisis in euro zone sovereign debt spills over to banks, according to documents obtained by Reuters on Wednesday.

In a report prepared for ministers meeting in Poland on Friday and Saturday, senior EU officials said the 17-nation currency area faces a "risk of a vicious circle between sovereign debt, bank funding and negative growth."

"While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic," the influential Economic and Financial Committee said.

The report highlighted European policymakers' challenge to restore confidence as the leaders of Germany, France and Greece held crucial talks by video conference on efforts to avert a Greek default that could cause a global financial shock.

Moody's Investors Service downgraded two of France's top banks, Societe Generale and Credit Agricole, saying its concerns about their funding and liquidity profiles had increased in the light of worsening refinancing conditions.

The ratings agency left France's largest bank, BNP Paribas, on review, saying its profitability and capital base gave it an adequate cushion to support its Greek, Portuguese and Irish exposure.

The euro and European stocks were earlier boosted by an announcement by the head of the European Commission that the EU executive would soon present options for issuing a common euro zone bond, despite fierce resistance in Germany.

Many investors see joint debt issuance as the best way out of the crisis since it would reassure markets that Europe's strongest economies were taking responsibility for weaker euro zone states.

But there is strong political and legal opposition in northern European creditor countries to underwriting the debts of what are seen as profligate southern states, making euro bonds a remote prospect.

European Commission President Jose Manuel Barroso told the European Parliament that closer union, particularly in the euro area, was the only way to reverse the negative cycle in financial markets.

"Today I want to confirm that the Commission will soon present options for the introduction of eurobonds. Some of these could be implemented within the terms of the current treaty, and others would require treaty change," he said.

But he warned that such bonds, which face political and legal obstacles in Germany and other north European creditor states, were no silver bullet to end the crisis, and could only be part of a comprehensive plan.

China added its voice to U.S. concerns over Europe's apparent inability to stop debt contagion spreading, while Indian and Brazilian officials said major emerging economies were discussing increasing their euro sovereign holdings.

U.S. Treasury Secretary Tim Geithner urged European leaders to act more forcefully to solve the escalating crisis, saying they have the economic and financial capacity to do so.

With senior EU and IMF inspectors due in Athens on Monday to check Greece's faltering compliance with its bailout plan, Chancellor Angela Merkel and President Nicolas Sarkozy were to press Prime Minister George Papandreou to enforce harsh austerity measures to meet fiscal targets.

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