BIS tries to calm market over toxic debt as IKB warns of losses near $1bn

The Bank for International Settlements (BIS) tried to soothe market nerves yesterday, saying the effects of the sub-prime credit crunch are less severe than in the 1998 financial crisis.

BIS's comments came as the first German bank to become embroiled in the crisis said it was pulling out of international inv-estments and would post a near-$1bn (£495m) loss this year as a result of its past involvement in racy debt.

The Basel-based BIS, which monitors financial markets and serves as a bank for central banks, said the risk premium demanded by investors and the slump in bank share prices were both less severe than in 1998, when Russia defaulted on its debt and the Long-Term Capital Management hedge fund collapsed.

In its report, BIS said: "Some investors began to draw parallels with the autumn of 1998, when the collapse of LTCM had triggered fears of instability in the banking system as a whole. However, the recent rise in US 10-year swap spreads was less sharp than at the time of the LTCM crisis."

Standard & Poor's, the rating agency, said last week that the credit crisis could hit investment banks harder than the aftermath of LTCM as they were forced to write down high-yield debt they couldn't sell. The US hedge fund LTCM imploded after Russia defaulted on $40bn (£20bn) of debt in August 1998 and investors pulled back from risky bonds. LTCM had bet the other way.

Credit markets hit turmoil in recent weeks as mounting defaults on US mortgages lent to people with patchy credit records caused global jitters because investment banks had packaged the loans as securities and sold them round the world.

The selling-on of the loans was meant to have made markets safer by dispersing risk, but markets are in a state of paralysis because no one knows who bears the risk for hundreds of billions of dollars of toxic loans.

One of the first casualties of the crisis was the German bank IKB, which had to be bailed out to the tune of ¿3.5bn (£2.4bn) by fellow German banks because losses from sub-prime mortgages threatened it with collapse. IKB's losses alerted financial markets to potential losses at banks few would have thought of as candidates for massive investment in high-risk securities.

IKB said yesterday it would go back to its roots as a bank for small businesses as it predicted a net loss for the current financial year of up to ¿700m compared with a pre-tax profit last year of ¿180m.

IKB's near collapse was followed by a blow-up at Landesbank Sachsen Girozentrale, which had to be bailed out with ¿17bn of emergency funds, again because of sub-prime losses. The banks had been selling cheap short-term debt to fund investments in higher-yielding assets through credit funds called structured investment vehicles (SIVs).

Bayerische Landesbank, Ger-many's second-largest state-owned bank, yesterday revealed it had ¿1.9bn invested in securities linked to sub-prime mortgages. The assets are contained in three conduits, off-balance sheet credit funds which are financed through cheap commercial paper. The bank said it was unlikely that its conduits, which have total investments of about ¿16bn, would be unable to finance themselves and if this happened the bank had enough cash to support them.

Germany's woes from the credit crisis have called into question the ability of management in its fragmented banking industry. Alexander Stuhlmann, the chief executive of state-backed lenderWest LB has said that German banks were in a "not uncritical situation" as foreign banks were reluctant to lend to them.