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July 12, 2011 7:39 pm
The jitters are back. With policymakers and private-sector creditors of the Greek government dragging their feet over the terms of how Greece’s sovereign debt burden should be restructured, the contagion effect has firmly taken hold of the banking market again and investors have driven down shares and bonds across Europe.
After a period of relative calm for many banks, it seems a collection of triggers – political and economic hiccups in Italy and Friday’s looming publication of potentially disturbing European bank stress test results, as well as the growing frustration at the Greek impasse – have combined to spook the holders of bank paper.
Though Italian banks on Tuesday reversed some of the dramatic share price slump of previous days, the shares of French, German, Spanish and even non-eurozone lenders in the UK, have been suffering. Spain’s Santander pulled an asset-backed bond issue. Also in Spain, it emerged that the debt crisis was threatening to derail the planned flotations of Bankia and Banca Cívica, two unlisted savings banks.
There are two reasons for the spreading fear. First, there is the rather hazy issue of macroeconomic sentiment. Political tensions between Italian premium Silvio Berlusconi and his finance minister Giulio Tremonti, in part over economic policy, helped put the underlying Italian fiscal position under the microscope. With the financial health of Spain, Portugal and Ireland still in question – and by some measures Belgium and France, too – banks in those regions, as key economic proxies, and as big sovereign debt holders, are obvious targets for market bears. It is the nagging question mark hanging over Ireland, the UK’s biggest trading partner, that poses the biggest eurozone threat to British banks.
Second, concerns are growing about the more complex interconnectedness of European financial groups. The stress test results should do something to clarify which banks are holding which risks, such as Greek sovereign debt, or Spanish real estate finance – so that the market becomes more discriminating in its bearishness. But analysts complain that key data points are still absent. Which institutions, for example, have been the big writers of sovereign debt credit default swaps – insurance policies that would pay out in the event of default?
The combined effect of those contagion concerns is increasingly persuading investors that buying or even holding European banks stocks is simply too risky at the moment. “The conventional wisdom is to say that if Greece defaults and the Greek banking system fails, even that would be manageable,” says one European banks analyst. Some of the biggest holders of Greek sovereign debt, such as France’s BNP Paribas, would be able to absorb even a 50 per cent “haircut” on the bonds with barely a murmur, given the scale of their capital cushions. “But to think like that is like saying a day before Lehman collapsed that I’m OK because I’ve only got $1 of Lehman shares,” he says. “There are chains of contagion that people are only now beginning to think about.”
With much of the market’s focus shifted from Greece to Italy, suddenly the scale of the potential knock-on is magnified. Global banks’ exposure to Italy dwarfs their exposure in the three eurozone countries that have already been bailed out – Greece, Portugal and Ireland.
In fact, at $262bn, the aggregate sovereign claims of foreign banks on Italy exceeds their combined sovereign exposures to Greece, Ireland, Portugal and Spain, which totals about $226bn, according to research by analysts at Collins Stewart.
European banks account for about 90 per cent of international banking exposure to Italy and 84 per cent of sovereign exposure, with French and German banks – as in Greece – by far the most exposed. French banks hold nearly $98bn worth of Italian sovereign debt, while Germany holds $51.2bn, according to the Bank for International Settlements.
Italy is such an integral part of the financial system that most developed countries have a material exposure – Japan, for example, has a sovereign exposure of $29bn, according to Collins Stewart.
Within Italy itself, about 65 per cent of domestic banks’ own equity is exposed to the sovereign, according to the BIS. To put that number into context, nearly 100 per cent of Greek banks equity is exposed to Greek government bonds, against about 30 per cent in France and about 15 per cent in the UK, according to the BIS.
Less than two weeks ago, senior policymakers and bankers were convinced that a Greek parliamentary vote passing a tough package of austerity cuts would give them some breathing space to draft a comprehensive second bail-out package for Athens.
The markets, however, have refused to give them that time. “There are some minor concerns over Italian fundamentals, but nothing new,” says one banker. “Markets are panicking because of disenchantment over European policymaking.”
“This is a binary situation,” says another. “Either there will be a catastrophe, or there will be a slow grinding technocratic solution to this mess.” Neither scenario offers much reason to own European bank paper.
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