A special report by A.M. Best found that European banks still face significant challenges in managing funding and liquidity.

Banks are competing for finite sources of funding amid the current recession, and costs are higher, putting pressure on profitability even as loan losses are mounting.

According to the report while, liquidity provided by national governments and central banks has safeguarded banks’ short-term positions, restoring prudent funding and liquidity profiles will be challenging and take several years.

A.M. Best believes that senior bank managers and regulators must act quickly to wean the sector off central banks’ funding and back to the wholesale market.

“Despite growing talk of a recovery, there is a lingering lack of liquidity in the financial markets, which is vital to the increased lending needed to help revive Europe’s economy,” the report stated.

A.M. Best’s analysis of the 10 largest European banks by assets shows their funding and liquidity profiles became exposed to market disruption as a result of rapid growth in loans; rising use of cheap, abundant wholesale funding; decreased holdings of government bonds; and increased usage of securitization.

Since 2007, securitization activity is down sharply, with most bank securitizations retained on balance sheet for collateral in obtaining funds from central banks.

The report concludes that private sector funding needs to replace central bank funding for the banking sector to begin operating as stand-alone institutions again and with the market's confidence.

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