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 IIF’s market monitoring group said in a statement Sunday. Some countries may also be put off from seeking aid because of the requirements, said the Washington-based IIF, which represents more than 450 financial companies.

Under the ECB’s plan, which helped drive the euro to a four-month high on Sept. 14, 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 stabilize markets, the IIF said.

The IIF’s risk group, headed by Jacques de Larosiere 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 stabilize 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)