March 13, 2012 / 11:21 AM / 8 years ago

UPDATE 2-Bundesbank builds buffer against euro bank loan risk

* Bundesbank 2011 profit 0.6 bln eur vs 2.2 bln eur in 2010

* Bundesbank raises risk provisions by 4.1 bln eur

* Says TARGET2 claims no risk because euro breakup scenario ‘absurd’ (Adds detail and background)

FRANKFURT, March 13 (Reuters) - Germany’s Bundesbank used a substantial part of last year’s profit to boost its risk buffer because of growing worries about the price euro zone central banks will have to pay for saving the bloc’s banking system.

The European Central Bank helped to avert a credit crunch by flooding the euro zone’s banking system with over one trillion euros ($1.3 trillion) in cheap 3-year loans, and also loosened the rules on what collateral it would accept from banks in exchange for the funding.

The Bundesbank has warned of the increasing risks the euro zone’s central banks have taken on as a result of such steps and this is also reflected in its balance sheet.

The Bundesbank’s 2011 profit fell to 643 million euros from 2.2 billion euros in 2010 as it raised its provisions for risks related to credit, exchange rate, gold and other prices by 4.1 billion euros compared with an increase of 1.6 billion euros in the previous year.

“The main reason for the decline in profit is the increase in risk provisions,” said Bundesbank President Jens Weidmann, who is also a member of the European Central Bank’s Governing Council.

“The counterparty credit risks arising from the government bond purchase programme and refinancing business have increased perceptibly as a result of the larger volume and the higher degree of risk,” Weidmann added.

Such risks are also reflected in the euro zone’s cross-border payment system, TARGET2, in which the Bundesbank has accumulated claims of around 500 billion euros - the highest position of any euro zone central bank payment system.

Weidmann, who also sits on the ECB’s governing council, had raised his concern about the ECB’s extensive liquidity provision already in February and tension between the Bundesbank and the ECB came to a head two weeks ago when a confidential letter from Weidmann to ECB President Mario Draghi was leaked to German newspaper Frankfurter Allgemeine Zeitung.

In an editorial published on Tuesday in Germany’s Frankfurter Allgemeine Zeitung and Dutch daily Het Financieele Dagblad, Weidmann repeated his concern about the TARGET2 imbalances, but said this did not pose a risk to its balance sheet.

“For me, the Bundesbank’s TARGET2 claims do not pose a standalone risk, because I think that a breakup of the currency union is simply absurd,” Weidmann wrote.

He added that he did not expect a euro zone member with TARGET2 liabilities to leave the currency union, and even in such an unthinkable event the losses would be shared by all central banks in the euro system according to the individual share of paid-in capital - known as the capital key.

Weidmann said the euro zone’s debt crisis also posed a risk to the German economy, which was, however, “in remarkably good shape”. (Reporting by Eva Kuehnen; editing by Stephen Nisbet/Ruth Pitchford)

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