CERNOBBIO, Italy (Thomson Financial) - European Central Bank board member Juergen Stark said euro zone banks' credit standards and lending were too lax before the U.S. subprime mortgage crisis led to sharp tensions in credit markets.
'The loosening of credit standards and a probably riskier lending attitude may be identified ex post as a weakness of the banking sector,' he said in a speech.
Banks also underestimated the risks associated with many assets, he said.
'There was a widespread underestimation of risks and a lack of transparency in the context of the extensive use of derivative products, partly related to their evaluation by rating agencies, leading to mistrust between market participants, an increase in the cost of funding and liquidity shortages in the course of the turbulences,' he said.
Stark said a prolonged period of low interest rates may have contributed to investors' appetite for risk.
'A global macroeconomic environment characterised by sustained growth, low inflation, muted long-term interest rates, a long period of very favourable credit conditions, abundant market and funding liquidity, and relatively low official rates may have strengthened investors' appetite for risk and increased the 'hunt for yield'. This, in turn, may have brought about an underpricing of risk,' he said.
He said more transparency and monitoring is needed on credit risks and where they ultimately reside in the financial system.
Market participants seem to have relied excessively on ratings of complex assets when making investment decisions, he added.
He said it is essential that there is smooth and effective cooperation and exchange of information between supervisory authorities and central banks in the detection of threats to the financial system.
Central banks also have to contribute to an orderly functioning of money markets and solidly anchor inflation expectations in order to avoid additional volatility in already highly volatile financial markets, he said. steve.whitehouse@thomson.com sw COPYRIGHT Copyright Thomson Financial News Limited 2008. All rights reserved. The copying, republication or redistribution of Thomson Financial News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Financial News.