Dangerous ‘war of loans’

FRANKFURT (Reuters) – Increased competition for mortgage, syndicated and consumer loans could damage financial stability if banks abandon prudent risk management, the European Central Bank said yesterday in its annual banking report. The ECB, a strong supporter of greater integration and competition in financial services, nevertheless expressed caution about banks’ syndicated and consumer lending after the banking sector continued its gradual consolidation over the past year. «The changing nature of banks’ activities and their linkages to each other have an impact on the industry’s long-term risk profile,» it said. The ECB does not directly supervise banks, but it does look out for threats to financial stability in Europe. Some of the national central banks regulate their home markets. The ECB said it was likely that banking competition would intensify over time, although cultural and consumer law differences in the 25-member EU would slow this process in the retail market. The report particularly noted changes in the growing market for syndicated loans, where several banks can share the risk of a single large debt. Margins for investment-grade debt had narrowed due to strong competition, and there were lower levels of risk compensation in the leveraged debt market. «A careful monitoring of the way in which this market segment is evolving and whether such developments signal potential risks is warranted,» the report said, adding that limited information on banks’ hedging strategy made a precise risk assessment difficult. Lending to the private sector is growing rapidly in the eurozone, fueled by interest rates which have been at an historic 2 percent low since June 2003. The ECB said more competition might lead to other types of riskier lending. «Intense competition in EU mortgage markets – should it result in a lowering of standards in credit risk assessment, too narrow margins or a greater exposure to markets that have shown some deviation of house prices from intrinsic values – could threaten financial stability,» the ECB said. Similar risks are potentially present in the consumer credit market, but most banks’ risk management practices were currently sound, it added. The ECB said it saw benefits in consolidation, as banks would be more stable if risks were spread across different regions and products.