European Central Bank President Jean-Claude Trichet said risksignals for financial stability in the euro area are flashing “red”as the debt crisis threatens to infect banks.

“On a personal basis I would say 'yes, it is red',” Trichet saidlate yesterday in Frankfurt after a meeting of the EuropeanSystemic Risk Board, referring to the group's planned “dashboard”to monitor risks. “The message of the board is that” the linkbetween debt problems and banks “is the most serious threat tofinancial stability in the European Union.”

Trichet, who chairs the ESRB, made the remarks as Europeanleaders meet in Brussels to discuss how to stave off a Greekdefault, while preparing a second bailout. The EU is trying toavoid a repeat of the financial crisis that followed the 2008collapse of Lehman Brothers Holdings Inc. and resulted in Europeangovernments setting aside more than $5 trillion to supportbanks.

The yield difference, or spread, between 10-year German bundsand Greek securities of a similar maturity was at 1,388 basispoints today, up from 1,317 at the beginning of the month. Swaps onGreece rose 25 basis points to 2,012, signalling an 82 percentchance of default within five years, according to CMA.

'Moral Support'
Greek bonds have beenpushed lower as authorities bickered over ways to support thenation. The ECB and the German government have clashed over howmuch investors should contribute to alleviating Greece's debt load,which reached 143 percent of gross domestic product in 2010. TheGerman government has argued for an extension of the maturities ofGreek bonds, with the ECB saying it opposes anything that could beinterpreted as a default.

While Greek Prime Minister George Papandreou earlier this weekwon a vote of confidence, bolstering his new government's chancesof pushing through austerity measures to secure further financialaid, European finance ministers said earlier this week they wouldhold off on approving a 12 billion-euro ($17 billion) payment tothe country promised for July until passage of the plans to cut thebudget deficit and sell state assets.

“European leaders will try and convince Greeks and financialmarkets when they meet in Brussels today and tomorrow that theyhave a workable plan to help Athens avoid a debt default,” saidAlan McQuaid, chief economist at Bloxham Stockbrokers in Dublin.They'll use a “mixture of arm-twisting and moral support” to forceGreece to adopt further reform.

'Serious Threat'
Federal Reserve ChairmanBen S. Bernanke downplayed the risk of a Greek default on U.S.banks, telling reporters yesterday that the impact would be “verysmall.” With “very few exceptions, the money-market mutual fundsdon't have much direct exposure to the three peripheral countrieswhich are currently dealing with debt problems,” he said.

The top U.S. prime money-market funds have about half theirassets in securities issued by European banks, Fitch Ratings saidin a report on June 21. The Bank for International Settlementsestimated European lenders held $136.2 billion in loans to Greeceat the end of 2010 and almost $2 trillion in Portugal, Ireland,Spain and Italy. Greece, Ireland and Portugal all received externalsupport.

BNP Paribas SA, France's biggest bank, and rivals SocieteGenerale SA and Credit Agricole SA may have their credit ratingscut by Moody's Investors Service because of their Greekinvestments, the ratings company said on June 15. German bankscould also be at risk from contagion, Fitch said last month.

“The most serious threat to financial stability in the EU stemsfrom the interplay between the vulnerabilities of public financesin certain EU member states and the banking system,” Trichet said.There are “potential contagion effects across the union andbeyond.

Basel Meeting

Part of a wider regulatory overhaul, the 65-member ESRB aims toidentify and warn of brewing risks in the financial system. Trichetand Bank of England Governor Mervyn King, vice- chairman of theboard, highlighted risks in areas including asset-price imbalancesand exchange-traded funds.

King is also at the center of a regulatory overhaul in the U.K.and will hold a press conference in London tomorrow on Britain'sFinancial Policy Committee. He said the ESRB meeting highlighted“the ability of banks to reduce maturity and, where relevant,currency mismatches in their funding structures and to absorblosses arising out of the ongoing credit cycle.”

The Frankfurt-based body can pass on matters to the heads ofEuropean governments if its warnings aren't heeded. While the bodywill monitor macro-prudential risks, it may turn its attention tosingle institutions deemed systemically important.

The ESRB is one of four bodies in Europe's financial regulationarchitecture. The others are the European Banking Authority, theEuropean Insurance and Occupational Pensions Authority and theEuropean Securities and Markets Authority.

The Basel Committee on Banking Supervision meets in Basel,Switzerland, today to discuss how much extra capital the world'slargest and most systemically important banks will be forced tohold to avert another financial crisis. Global central bankgovernors are scheduled to meet under the auspices of the BIS inBasel from June 25.

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