Analyst warns that potential losses for nation's lenders remain unclear

BEIJING - Chinese banks should prepare technically and strategically for a partial break-up of the eurozone, said an analyst at Bank of China Ltd (BOC) on Wednesday.

The biggest risk for Chinese lenders lies in securitized euro-denominated debt, said Li Jianjun, an international finance analyst at BOC, one of the four biggest State-owned lenders by market value.

"That will be a big problem, because banks have to clear up not only euro debt but also related debt if the situation worsens," he said.

An exit of some weaker members from the eurozone might be the worst-case scenario, but market participants are already preparing, even though government officials in the zone continue to deny the possibility of that outcome, Li said.

He said that although Chinese lenders have become more prudent since the start of the sub-prime crisis in the US, they still held such debt.

"BOC might not be the worst-affected Chinese bank in the worst-case scenario. It's still unclear how much the country's lenders will lose if some economies start to use their own currencies instead of the euro."

As the most internationalized Chinese lender, BOC was included on a list of 29 globally systemically important financial institutions in early November by the Financial Stability Board, an international policy coordination organization.

"Undoubtedly, the global foreign exchange market, which is valued at $4 trillion each day, will suffer great shocks if the eurozone partially breaks up and the whole trading system changes."

The Wall Street Journal reported last week that at least two global banks had taken steps to install back-up technology systems that could handle trading in the former European currencies.

The newspaper said that banking regulators in the UK and US had asked major banks to update their levels of preparedness in recent weeks.

British media reported on Monday that the UK Treasury was working on a contingency plan for a potential euro meltdown that includes capital controls. Banks in the eurozone placed a record amount of overnight funds at the European Central Bank (ECB) on Wednesday, a sign that they are increasingly wary that each other might default.

"The possibility of any exit from the eurozone is still quite limited, judging from the current situation, as the ECB already took some loosening measures," said Tang Jianwei, economist at Bank of Communications Co Ltd.

Last week, the ECB agreed to lend 523 euro area banks a total of 489.2 billion euros ($639.5 billion) to ensure lenders have enough liquidity.

Wang Tao, head of China economic research at UBS Securities Co Ltd, said the ECB is likely to undertake further quantitative easing to cope with the debt crisis. "But without a fundamental reform across the euro area, the moves may not be enough to stabilize the market."

"A break-up of the 17-member state Euro Area, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic," according to Willem Buiter, chief economist at Citigroup Global Markets Inc.

An exit, partial or full, would likely be precipitated by disorderly sovereign defaults in the fiscally weak and uncompetitive member states, whose currencies would weaken dramatically and whose banks would fail.

There would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression if Spain and Italy were to exit the euro, he said.

Ji Ran contributed to this story.