The sovereign debt crisis wreaking havoc on the euro zone is spreading to healthier members of the single-currency club. It now threatens to engulf the entire region’s still-wobbly banks, whose deep financial troubles have played a key role in the unfolding debacle.
Investors continue to shun bonds issued by debt-ravaged Greece and Ireland, which were forced to take bailouts orchestrated by the European Union and International Monetary Fund. They have been shedding debt from Portugal and Spain, which they fear will be next in line for massive handouts. And now, they are also selling Italian, Belgian, French and even German bonds, considered the safest in Europe.
Meanwhile, banks across Europe are sitting on hundreds of billions of euros worth of government bonds that are rapidly falling in value, or relying on them as collateral for vital cash infusions from the European Central Bank. And many are on the hook for heavy losses stemming from loans to banks and borrowers in Portugal, Ireland and other troubled parts of euroland.
The growing risks to Europe’s banking system have been a driving force in the bailouts of first Greece and now Ireland.
“There’s definitely a banking problem in core Europe, outside of the peripheral economies,” said Marko Papic, senior European analyst with Stratfor, a global intelligence firm based in Austin, Tex.
Portugal’s central bank warned in a report on Tuesday that the country’s banks will be put in an impossible position unless the government can get its soaring deficit under control, and the European debt contagion can be halted.
“The risk will become intolerable if we do not see the implementation of measures that consolidate public finances in a credible and sustainable way,” the bank said.
Yet Portuguese banks are actually in better shape than those in neighbouring Spain or in Ireland and Germany, because they were never as heavily leveraged internationally and mostly avoided the bad bets on real estate, derivatives and sub-prime loans that shredded balance sheets in several other banking systems.
Their biggest risk is that, as in Ireland, depositors will take flight, particularly corporate clients that have much greater flexibility to move their money, analysts say.
Portugal’s banks are relatively small, with less than half the assets of Ireland’s financial sector. But if they go down, they will inflict considerable damage on other lenders throughout the region. Neighbouring Spain’s banks are on the hook for $77-billion (U.S.) worth of exposure to Portugal, including government bonds; French banks for $41-billion; German for $37-billion and British banks for $22-billion.
“There’s a desire to draw the line at Spain,” said Drummond Brodeur, vice-president and portfolio manager at Signature Global Advisors
Another reason is that Spain’s own banks are much larger than those of Ireland or Portugal, raising the spectre of the problem spreading quickly to other European banks. But Mr. Brodeur pointed out that Spain’s banking problems are generally with its smaller regional banks, making it easier to contain the crisis without a bailout.
Bank stocks throughout the region have fallen steadily in response to the drumbeat of negative news. BNP Paribas, the largest of the French banks, has seen its shares fall for eight consecutive days, and a similar fate has befallen other major European players such as Dutch giant ING.
“I don’t believe that financial stability in the euro zone could really be called into question,” ECB president Jean-Claude Trichet told policy makers in Brussels. People are underestimating “the determination of governments,” he said.
But Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group, told Bloomberg that Germany and its banks have to be threatened by the crisis before a long-term solution for the region can emerge. It “may take a near-death experience for the periphery and core EMU banking systems before this realization dawns.”
With a report from Barrie McKenna
