ECB warns Europe's banking sector is open to fresh shocks

Its chief economist fears new rules could cause more harm than good...

Rising levels of bad loans and higher costs have increased the chances of a "severe profitability shock" according to the European Central Bank’s chief economist, Peter Praet.

He said that the banking system is suffering from a "lack of consolidation, overcapacity, and legacy problems" which mean that the system remains "highly cyclical" making it exposed to shocks.

Mr Praet added that untested new rules to protect the banking system have become the biggest source of instability.

"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.

He added that the EU's bail-in laws, which are designed to imposed losses on bank shareholders and creditors in the event of a shock, are a serious potential source of instability 

The rules came into practise on January 1st - they are yet to have been called upon.

Investors have feared that the rules could result in high costs for private sector creditors.

The economist also added that low interest rates pose risks which are not addressed by current banking regulations.