Euro zone banks face profitability shock, need to consolidate: ECB's Praet

BRUSSELS (Reuters) - Euro zone banks are facing a severe profitability shock, European Central Bank chief economist Peter Praet said on Tuesday, urging more consolidation in the sector to make it more competitive.

Speaking at a conference in Brussels, Praet said that overcapacity, high costs, higher competition, an excess of bad loans in some countries and a lack of necessary consolidation are squeezing banks' profits in the euro zone.

"We have in the sector a severe profitability shock," Praet said. "In a context of a smaller pool of earnings, you have clearly overcapacity in the sector," he added.

Banks are also facing competition from new players such as hedge funds or fintech companies specialized in payment services, he said.

To reduce costs and make banks more profitable, Praet, who is also an ECB board member, said more consolidation would be helpful, and he urged the creation of "truly pan-European banks".

This would be the final stage of the banking union, the EU flagship plan for financial stability, Praet said, calling for a quick completion of the project.

But Christophe Nijdam at Finance Watch, which campaigns for the public interest in financial services rulemaking, said more consolidation in the banking sector would lead to more problems as it would make it more difficult to let larger lenders fail without the involvement of taxpayers.

After establishing a common supervisory body and a joint fund to rescue failing banks, the euro zone states have stalled due to disagreements over setting up a common scheme to insure bank deposits of at least 100,000 euros ($113,220).

Praet also urged new rules to address risks posed by low interest rates.

"Interest rate risks in banking is something that is still missing in the regulatory environment and should be a priority in the present context," he said.

Praet also said the main concern regarding the financial stability of banks in the euro zone is that new EU rules on rescuing lenders without using taxpayers' money have not yet been tested on them.

"On paper we have much better recovery and resolution processes, but they have not been tested yet. I would still put a question mark on this," he said.

(Additional reporting by Balazs Koranyi; Editing by Hugh Lawson)