Stock markets fall as eurozone debt fears persist

Bank shares and the euro fell on Monday as fears over the eurozone persisted.

European stock markets slumped about 3%, as the value of the big banks retraced much of the gains they had made since a new rescue deal was agreed by eurozone leaders last Wednesday.

The euro fell 1.5% against both the dollar and the pound.

Worry over the Italian government's ability to finance itself remains at the heart of the crisis, as Rome's cost of borrowing rose to new highs.

Sentiment towards financial stocks was further hurt by the failure of US brokerage firm MF Global, due to its exposure to eurozone government debts.

Banks drop back

Continental banks remain heavily exposed to the debts of troubled European governments, as well as a general flight of cash from the European banking system that emerged over the summer.

France was worst hit, with Societe Generale down 9.8% and BNP Paribas 9.6%, while in Germany Deutsche Bank dropped 8.6% and Commerzbank 8.5%.

The UK did not escape, with Royal Bank of Scotland down 7.8% and Lloyds 7.6%.

However, Europe's banks still remain well above the lowest levels seen in the last two months.

As part of the new rescue deal, European Union leaders agreed that their banks must increase their capital - their buffer against future losses - by 106.5bn euros ($150bn: £92bn).

This will likely be done by issuing new shares, either to private buyers or to the governments themselves, something that is likely to dilute the value of existing shares.

Banks were also asked by European leaders to accept a 50% write-off of the debts owed to them by Greece.

However, the Greek Prime Minister, George Papandreou, announced after share trading had closed in Europe that he would put this agreement to a referendum, raising a question mark over whether it will go ahead.

Share prices on Wall Street - including shares in European banks that are traded there, such as Deutsche Bank - did not noticeably react to the news.

However, US shares did broadly continue to slide after the close in Europe, with the Dow Jones finishing 2.3% lower. US banks Morgan Stanley and Bank of America were among the worst performers.

Self-fulfilling fear

Meanwhile, Italy's 10-year cost of borrowing in bond markets has risen to 6.1%.

That is still slightly short of the highest level since Italy joined the euro, which was seen in early August, and prompted the European Central Bank (ECB) to start buying up Italian debt.

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Media captionHow is the European Central Bank helping the banks?

However, markets are rattled by the fact that Italy's borrowing costs have crept up again despite the ECB's intervention, and despite a revamp of the eurozone's bailout fund, intended to assist Italy.

Moreover, Italy's shorter-term borrowing costs have risen even more sharply, to their highest euro-era levels.

Rome now has to pay 4.5% interest to borrow money for just one year, even though the German government must pay only 0.4% over the same period.

The difference reflects the potentially self-fulfilling fear of lenders that Italy may not be able to repay its large existing debtload unless it is able to reborrow the money from markets as the debts come due for repayment.

There are also fears that Europe may be sliding back into recession, which would make Italy's debts even harder to repay.

On Monday, the Organisation for Economic Co-operation and Development became the latest international body to warn of a possible global economic downturn.