Stark Says Risk Underpricing Is Key Banking Weakness

European Central Bank Executive Board member Juergen Stark said recent financial market turmoil shows the need for better banking supervision.

The ``underestimation of risks'' is a ``key weakness of the banking sector,'' Stark said in a speech in Cernobbio, Italy, today. ``More transparency and monitoring is needed on the credit risks and where they ultimately reside in the financial system.''

Banks and securities firms have posted $232 billion in asset writedowns and credit losses globally stemming from the collapse of the U.S. subprime mortgage market. At least 34 European Union- based banks have racked up about $62 billion of writedowns and $10 billion of credit losses.

The turmoil has highlighted that ``some risk categories have been underestimated, especially liquidity risks relating to banks' commitments to structured investment vehicles and conduits,'' Stark said. ``Market players seem to have relied excessively on ratings of complex assets.''

Stark called for a ``smooth and effective cooperation and exchange of information'' among supervisory authorities and between the supervision bodies and the central banks.

European finance ministers yesterday pledged to improve their oversight of the region's different banking systems by backing more cooperation in monitoring lenders and preparing for any future crisis. ``We do not have satisfactory arrangements in place to deal with such a situation'' of a multinational bank failing, EU Commissioner Charlie McCreevy said in an interview.

`Volatile'

To avoid ``additional volatility in already highly volatile financial markets'' central banks should contribute to an orderly functioning of money markets and ``solidly anchor inflation expectations,'' Stark said.

The ECB will keep providing liquidity to ensure that banks are able to finance themselves overnight at rates close to the central bank's 4 percent benchmark, ECB Executive Board member Lorenzo Bini Smaghi said yesterday.

``Banks do not seem to have fully understood this policy as they continue to bid for liquidity in the weekly, three-month and six-month ECB tenders at much higher interest rates, apparently pricing in a risk that does not exist at all,'' he said.

The cost of borrowing in euros for three months yesterday held at the highest since December, a sign that banks are hoarding cash despite attempts by policy makers to revive interbank lending.