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European banks are a source of nervousness to policymakers around the world. The eurozone economy is flat on its back. Growth will be between minus 4.1 per cent and minus 5.1 per cent this year, recovering to perhaps minus 1.0 per cent and 0.4 per cent next. With the negative feedback loop between the financial sector and the real economy in full swing, this is a time for conservatism in banking. The European Central Bank’s latest six-monthly financial stability review, however, suggests euro area banks have absorbed barely 60 per cent of losses estimated for 2007-2010. Eurozone banks could face cumulative total losses of $218bn on their securities and an additional $431bn of losses on their loan books, making a total of $649bn.

If the writedowns to date on securities have been comprehensive, the same cannot be said of those for loan exposures. In 2007 and 2008 euro area banks provisioned and wrote off just $150bn of their loan exposures, meaning $280bn of estimated loan losses have yet to come home to roost. Accounting rules allowing banks to delay writedowns and the murky outlook for bank profits add an unwelcome layer of uncertainty. Brussels is busy overhauling financial supervision for the next crisis. Investors in European banks, meanwhile, need transparent stress tests to prove they have enough capital to survive this one.

If the economy fails to recover as rapidly as hoped, the fudge factor will rise. Already, most of Europe’s biggest financial companies employ aggressive accounting practices that may mask their true financial condition, according to Audit Integrity, an accounting and governance research firm. About half of the 25 financial groups in Europe with a market value of more than $7bn employ accounting that the firm deems “very aggressive”. A further seven merely utilise “aggressive” accounting. Just one, Groupe Bruxelles Lambert, is deemed “conservative”. At this stage that is simply far too few for comfort.

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