Banks in the eurozone will suffer "considerable" loan losses in 2010 and 2011, potentially leading to €195bn (£165bn) in futher write-downs, the European Central Bank (ECB) warns.
In its latest Financial Stability report, the ECB says public finances pose the biggest threat to the eurozone, the Telegraph reports.
"We are experiencing now a second wave of write-downs, which relate to the performance of loans," the ECB's vice-president Lucas Papademos said.
The report comes as figures show May was the worst month for European stock markets since February 2009, because of fears about a sovereign debt crisis in the region.
The FTSE 100 lost around 365 points, or 6.6%, in May which is the worst monthly performance since a 7.7% fall in February last year during the depths of the global downturn.
Shares across Europe fell 5.8% last month. Markets in London and the US were closed yesterday, but shares in continental Europe shook off the cut to Spain's credit rating on Friday, with stock markets rising 0.3%.
Bond markets also largely took Spain's downgrade in their stride. The spread between Spanish government debt and German government debt widened by seven basis points to 164 basis points, but analysts do not expect the gap to widen much further when UK and US markets re-open today.
Spain has found itself in the spotlight of investor concern over its sovereign debt, after a bail-out of Greece was agreed last month.
Ratings agency Fitch stripped the indebted nation of the top AAA credit rating on Friday after the markets closed. The downgrade to AA+ followed Standard & Poor's decision to downgrade Spain in April to AA with a negative outlook.
Spain has pushed through an austerity package and risks a wave of strikes in opposition to labour market reforms.
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