The Financial Services Authority (FSA) has stepped up scrutiny of UK banks' exposures to foreign government debt as fears of European sovereign debt contagion sent markets into a renewed frenzy yesterday.
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The City watchdog is in talks with Britain's banks and their auditors to ensure consistent disclosure of their sovereign holdings according to the standards of the recent European stress tests in their year-end results.
As fears over which banks could be hit by downgrades of sovereign bonds continue to rattle markets, the FSA has also upped its day-to-day monitoring of UK lenders' exposures.
An FSA spokeswoman said: "We have been holding discussions with the banks and their auditors in relation to their sovereign exposures. What we are looking for is greater consistency and disclosures across firms to give the market clear information."
Yesterday marked another round of turmoil for Europe's banks as fears about exposures to debt-stretched economies made investors question their ability to fund in the market.
Shares in Société Générale gyrated as the French lender sought to stamp out doubts about its financial strength. The bank was the focal point of Wednesday's rout of bank shares.
SocGen's chief executive, Frederic Oudea, staged a fightback overnight, dismissing negative speculation as "absolute rubbish". He called for the French market regulator to investigate the source of market rumours.
"People are scared so the tiniest information touches off irrational fears," he said. "[Our clients] should not listen to this stuff, which is totally baseless."
His comments rallied the shares but they then fell more than 9 per cent in a day of frenzied trading before closing up 3.7 per cent. Speculation about a European ban on short selling helped boost shares. BNP Paribas, France's biggest bank, closed up slightly after falling up to 7.5 per cent earlier.
However, average short interest across the Euro Stoxx banks sector was 2.85 per cent, only marginally above the average for European companies in general, according to Data Explorers figures. Short interest in SocGen was 1.23 per cent and was 1.95 per cent for BNP Paribas.
The figures suggest short selling was not a major factor in the banks' declines, though rumours planted by a few short sellers can wreak havoc.
The cost of insuring SocGen's senior bonds hit a fresh record, according to data provider CMA. Speculation about a downgrade of France's sovereign debt, a bigger bailout for Greece and the bank's ability to raise funds put SocGen shares under pressure.
Banks' overnight borrowing from the European Central Bank hit a three-month high as prices for inter-bank lending showed Europe's banks increasingly unwilling to lend for longer than overnight.
Analysts at Royal Bank of Scotland said SocGen was among European banks that rely most heavily on short-term wholesale funding.
"The mix of euro doubts and rating fears in recent days and weeks may have dented the confidence of funding counterparties, which has then fed back into equity markets," they said.
Markets rebounded after heavy falls the day before but sentiment was highly volatile. The FTSE 100 dropped as much as 1.3 per cent but rounded off the day up 3.1 per cent at 5162.83. The rally was led by Barclays which jumped 8.6 per cent and recovered almost all Wednesday's losses.
European shares registered their biggest surge for 15 months as the Stoxx 600 index jumped 3.2 per cent. However, the index has fallen 21 per cent since it hit a high for the year on 17 February.