International regulators raised the pressure on European policymakers to shore up the continent’s banks, warning the impact of the sovereign debt crisis on bank capital posed an escalating threat to financial stability.

The European Systemic Risk Board, a new body comprising central bankers and supervisors, called for concerned action to head off “rapidly rising” threats.

“Supervisors should coordinate efforts to strengthen bank capital,” the ESRB said. “The high interconnectedness in the European Union financial system has led to a rapidly rising risk of significant contagion. This threatens financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond.” .

In its global financial stability report, released on Wednesday ahead of its annual meetings, International Monetary Fund staff stuck by their estimate that Europe’s sovereign debt crisis had delivered a €200bn ($273bn) hit to European Union banks since 2010, an analysis that has provoked fierce arguments with eurozone governments.

European policymakers challenged the IMF’s findings.

“I would agree with the thrust of the IMF report...I don’t share their assessment on bank capital,” said Michel Barnier, European commissioner for the single market. “The vast majority of European banks are well capitalised and those that were shown to need capital by the stress test are raising it. We did not wait for the IMF to make Europe’s banks stronger.”

IMF staff estimated that, based on the movements in credit default swap spreads, falls in sovereign bond prices of the troubled peripheral eurozone countries since the crisis began last year had reduced the value of EU banks’ holdings by €200bn.

It said that the hit on European bank balance sheets would rise €300bn if the knock-on effects of banks’ holdings in each other were taken into account.

The IMF’s €200bn figure – first revealed in the FT three weeks ago – provoked heated exchanges between the IMF and eurozone countries.

Eurozone officials have claimed that they have forced the fund to back down from estimates that EU banks would need €200bn in fresh capital, saying that the prices of other assets on their balance sheets had risen to compensate.

But the fund has underlined that its analysis was only ever a specific review of the precise impact of peripheral sovereign debt turmoil rather than a full stress test and assessment of capital requirements.

It said the deep interlinkages between banks in Europe magnified any shock coming from a troubled sovereign. “Because banks lend to banks, the system is highly interconnected, both within and across borders,” the report said.

“Consequently, the banking system can amplify the size of the original sovereign shock through funding markets.”

Without giving a number, the report nonetheless argued that many European banks clearly needed much higher capital buffers than at present – an argument made last month by Christine Lagarde, the IMF’s managing director, which touched off more controversy

The ESRB is chaired by Jean-Claude Trichet, president of the European Central Bank. Its appeal highlighted a growing conviction among Europe’s central bankers that strengthening banks balance sheets offers the best way of tacking the eurozone crisis. In a swipe at bickering eurozone politicians, it also called for “enhancing the coordination and consistency of communication”.

The IMF report said credit, market and liquidity risks had all risen since the previous report in April, with monetary conditions the only aspect of financial market stability not to have worsened.

“The crisis – now in its fifth year – has moved into a new, more political phase,” the IMF report said.

Although the eurozone had taken important steps to address the crisis, such as the deal announced on July 21 to provide more official assistance to Greece, “political differences within economies undergoing adjustment and among economies providing support have impeded achievement of a lasting solution.”

The IMF report also said that while it had yet to show up in Treasury yields, the political stand-off over raising the US debt ceiling in August had increased volatility and uncertainty in financial markets.

Eurozone governments have been accused of letting the Greek situation worsen rather than cauterising the wound by forcing Athens to restructure its debt. Such a move would damage the balance sheets of the many eurozone banks that hold Greek sovereign bonds.

The Financial Times