10/06/2011 05:39 EDT | Updated 12/06/2011 05:12 EST

EU banking watchdog to report on lenders' ability to withstand deeper losses on Greek bonds

BRUSSELS - European regulators are examining whether banks on the continent have big enough buffers to sustain the worsening market turmoil, amid fears that a default by Greece could trigger another credit crunch and recession.

One of the scenarios the European Banking Autority will look at in a new report on lenders' capital levels will be larger losses on Greek government bonds, a European official said. The fear in the market is that such an event could cause a severe credit squeeze, as happened in 2008, that would even threaten banks not exposed directly to Greece's debt.

European Union finance ministers will discuss the results at their next meeting in early November, said the official, who was speaking on condition of anonymity because of the sensitivity of the issue.

The EBA said the exercise was not a new round of stress tests and would be based on the same figures as stress tests published in July, when only nine banks failed the test and 16 others barely passed.

The president of the European Commission, Jose Manuel Barroso, said that the EU's executive was preparing proposals for a co-ordinated recapitalization of the banking sector, after German Chancellor Angela Merkel backed such a move Wednesday.

"We are determined to do everything necessary to ensure that Europe's banks are able to play their essential role in lending to citizens and businesses. Recapitalization efforts are well under way, additional efforts may be needed," Barroso said. "Close co-ordination at European level is of course essential."

Barroso declined to go into details of the proposals or comment on how much money may be needed.

Speculation that Europe is looking at a co-ordinated plan to recapitalize its banking sector has been the main reason why stock markets have rallied over the past couple of days following a dismal start to the week.

Franco-Belgian bank Dexia SA has been at the forefront of investor concerns this week over its exposure to potentially bad government debt and its share price has been under severe pressure. The French and Belgian governments have indicated that some sort of deal to save the bank could be announced later Thursday.

The International Monetary Fund, a key player in the eurozone debt crisis, said lenders across the continent may need as much as €200 billion ($267 billion) to boost their capital cushions enough to restore a loss of confidence in the sector.

Some of that money could come from private investors via capital increases, but analysts expect that governments may have to put up significant amounts for lenders than can't raise money on the markets.

The EU disputes the IMF's €200 billion estimate, but has been warning that lending between banks and from banks to businesses is threatening to freeze up. Some analysts have warned that this freeze could soon create conditions similar to the aftermath of the collapse of U.S. investment bank Lehman Brothers in 2008.

However, some countries have been slow to set up sufficient backstops for their lenders, reluctant to commit more public money as they are already under pressure over their high debt levels.