Bankers see threat to economy of risk-aversion

LONDON (Reuters) - A prolonged credit crunch could sap the risk appetite of banks, prompting them to rein in lending and possibly undermine the buoyancy of the real economy.

Bankers and analysts attending the Reuters Finance Summit said as banks become increasingly distracted by sorting through and writing down exposures to mortgage-backed securities, the mainstream business of lending to clients could suffer.

"Potentially what will change is the risk appetite of players so far as new products, risks and innovation (are concerned), and potentially the risk appetite of the banking system," Sergio Ermotti, deputy CEO of Unicredit (CRDI.MI), said at the summit held at Reuters offices in London on Tuesday.

Problems banks face in writing down exposures are likely to be a major preoccupation for some time to come.

"We still don't know where the $200 to $250 billion of subprime losses are. We need clarity on who is sitting on what exposure," said Huw Van Steenis, head European banks analyst at Morgan Stanley.

But the potential impact of the crisis on economic growth was starting to loom larger.

"Will the liquidity and credit crisis bring down growth in the U.S. and will that bring down the world economy? This is the issue which investors are very much grappling with," said Van Steenis.

A repricing of risk which has taken hold as a credit crisis has unfolded, triggered by the unraveling of U.S. subprime mortgages, is driving up funding costs for banks, which are passing those costs on to borrowers.

"How will this be then reflected in the real economy?" asked Ermotti. "If those costs of funding for the banking system are still there in the next quarter, this will become very clear to the economy."

EXTRA COSTS

Even a fall in interest rates may not be enough to soften the impact as funding costs creep up.

"A cut in the base rate by one quarter or one half of a percentage point may not be enough to offset the extra cost of funding because of credit spreads widening," said Ermotti.

Global banks have taken charges running to more than $20 billion on holdings of mortgage-backed securities, whose value has been pummeled by a meltdown in U.S. subprime mortgages, which are loans made to people with poor credit histories.

With U.S. banks such as Citigroup (C.N) and Merrill Lynch MER.N bearing the brunt of the subprime debacle, investors are increasingly concerned that a collapse in the U.S. mortgage market will lay low the economy.

Although bankers say it will take several more months to flush out all their subprime-related exposures, they may need a good deal longer to recover their composure and restore confidence to management teams.

"The danger is that people seek to protect their position and jobs rather than build the business," said Alex Wilmot-Sitwell, global co-head of investment banking at UBS. "The worst thing is to start becoming introspective."

UBS is one of the European banks to have been worst hit by the subprime crisis, last week unveiling its first quarterly loss in five years after taking more than 4 billion Swiss francs in writedowns on subprime-related exposures and warning of more to come.

The biggest challenge banks face may be moving on from fire-fighting to growing their businesses again in an environment plagued by uncertainty. That may prove even more challenging for banks than cleaning up their balance sheets.

"I would expect the transparency and cleanup process will be very quick, not much longer than the end of the year, as I don't think it's sustainable for any bank to say it takes months to explain what happened," said Ermotti.

"We have to be prepared for an environment where there is dislocation and uncertainty will prevail."