Market Risk - Europe Simulates Financial Meltdown

Europe's financial regulators have held a "war game" exercise, simulating a continent-wide financial crisis, amid fears they are ill- prepared to stop a problem in one country spreading across borders.  The exercise involved simulating the collapse of a big bank with operations in several large countries to see whether the European Central Bank, national central banks and finance ministries could work together to contain the crisis.

It is understood the exercise took place at the headquarters of the ECB in Frankfurt last week. One person involved said: "It is like checking whether a nuclear power plant can survive a plane crashing into it."  The exercise took place on the eve of a meeting of European Union finance ministers and central bank chiefs in Vienna.  Officials at the meeting confirmed that ministers had discussed the ECB crisis management exercise.  The aim was to test the ability of national regulators to share information with other national bodies in a crisis and to overcome "differences in culture" and other practical obstacles.  The results are being analyzed and will be reported to the Ecofin council in June.

Europe's vulnerability to a cross-border financial crisis was revealed in a confidential report prepared by officials for the Ecofin council.  Regulators are particularly worried about the risks to financial stability posed by the growth in hedge funds and credit derivatives.  It said that "progress has been insufficient in most of the member states" in putting in place national structures for crisis management and urged national regulators to stage their own crisis simulation exercises.

The EU has rejected the creation of a single European financial regulator to manage cross-border risks and has instead placed its faith in national authorities working together.  Last year regulators signed an agreement that they would share information openly and speedily in the event of a crisis in a national financial institution, in an attempt to stop the contagion spreading across Europe's single market.

The report submitted to the Ecofin council identified a possible housing market crash, a bird flu pandemic and high oil prices as potential sources of risk, but said that the situation in the banking sector was "solid".  However, the report warned that hedge funds and credit derivatives were sources of concern "as related risks remain opaque and they have become extremely relevant in assessing financial stability both across borders and across all financial sectors".