THE INSTITUTE of International Finance warned that the European Central Bank’s plan to buy sovereign bonds may result in a “cliff effect” if a country fails to meet conditions tied to the purchases.

Termination of bond purchases could lead to an “abrupt” market correction, the institute’s market monitoring group said. Some countries may also be put off from seeking aid because of the requirements, said the Washington-based institute, which represents more than 450 financial companies.

Under the ECB’s plan, which helped to drive the euro to a four-month high last week, the central bank would buy government bonds in tandem with Europe’s bailout funds to stem rising borrowing costs if countries ask for help and agree to conditions.

The ECB will also assume oversight of the region’s banks as early as the start of next year under plans for closer integration among Europe’s lenders.

A timely implementation of a single banking supervisor will allow the bailout mechanism to lend directly to the banks and also help to stabilise markets, the IIF said.

The IIF’s risk group, which is headed by Jacques de Larosière, a former managing director of the International Monetary Fund, and David Dodge, urged European governments to pursue structural reforms that will ensure a path to economic growth, echoing concerns by the ECB that it has only bought nations time to implement reforms needed to stabilise their economies.

Further delays in reviewing Greece’s budget-cutting plans and unblocking aid “would be a key source of event risk,” the IIF said. – (Bloomberg)