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Analysts are poring over new statistics on debt exposure from the Bank for International Settlements released today. As has become customary with each quarterly release of this data, the report’s (virtual) pages are flipped directly to the section detailing the size of banks’ portfolio of bonds issued by governments on the euro area’s troubled periphery.
French and German banks are the most exposed, by far, to troubled government debt. Although banks have been reducing their exposure—the value of debt from Greece, Ireland, Portugal and Spain held by foreign banks fell by 35% last year—significant holdings remain. German banks, for example, were sitting on more than 40% of the US$54bn in foreign-held Greek government debt at the end of 2010.
The inevitable restructuring of Greek debt will be painful for lenders, although the severity will vary according to the method employed. In the meantime, attempts to cajole banks into a voluntary refinancing of Greece’s daunting debt pile (along the lines of the “Vienna Initiative” in central and eastern Europe) will continue, despite a glaring lack of incentives for lenders to take part.
As ever, the IMF’s latest Global Financial Stability Report is worth a look, not least because the organisation’s chart makers seem to be getting a lot more creative. Some of the infographics in the report’s latest edition verge on the psychedelic.
More importantly, however, the IMF issues a stern rebuke to financial regulators for “incomplete policy actions and inadequate reforms”. The global banking system remains vulnerable to shocks, as some lenders remain “caught in a maelstrom of interlinked pressures”, the IMF warns.
Euro area banks are singled out as particularly vulnerable. Thinly capitalised and more reliant on wholesale funding than many of their counterparts elsewhere, some of the currency union’s banks—particularly those in the bloc’s troubled periphery—are now shut out from most funding markets. This is reflected in the interest rates that the most desperate banks are offering on deposits, seeking to reduce their reliance on official support by luring funds from wary savers.
The rate hikes by Greek, Portuguese and Irish banks in recent months have been significant, dampening these institutions’ profitability and prolonging an already protracted recovery process. Another interesting conclusion to draw from the chart—adapted from the one that appears in the IMF’s report—is that banks in Italy seem relatively more desperate for deposits than banks in Spain.
There was some respite for Spain and Portugal this week, as both of the embattled euro-area members held relatively successful bond auctions. Analysis of the bond sales can be found at the parent site: “Spain: Unsteady balance” and “Portugal: Hard sell”.
Although benchmark yields in Iberia have had a good week—since Monday, the Portuguese ten-year government yield has fallen by 44 basis points while Spain’s has dropped by 21 basis points—the news coming from the countries’ banks is less encouraging. Still largely shut out from the capital markets, both Spanish and Portuguese banks boosted their borrowing from the European Central Bank last month. Data released this week show that Spanish banks relied on €67bn in funds from the ECB in December, up from €61bn the month before; Portuguese banks, meanwhile, tapped the ECB for €41bn in December, up from €38bn in the previous month.
For Portugal, the Economist Intelligence Unit believes that it is a question of when, not if, the country will seek access to the EU/IMF emergency credit facility (probably during the first half of this year). Spain is expected to service its debt without resorting to a bail-out, although its beleaguered banking sector remains a major downside risk to the sovereign.
As financial markets anxiously await the results of stress tests on Europe’s largest banks, questions are being asked about the level of detail that will be provided on lenders’ exposure to troubled sovereign debt. After all, a key aspect of the test is the ability of Europe’s banks to withstand a “sovereign risk shock”.
New data from the Bank for International Settlements (BIS) provides some new, if vague, clues on banks’ exposure to the countries most at risk under the stress test’s sovereign-shock scenario. The BIS data, updated through the end of March, gives the total exposure of a country’s banks to borrowers abroad. It does not break out the types of debt—personal, commercial, sovereign—but instead gives a general indication of which banks might be the most exposed to Europe’s trouble spots.
Not surprisingly, most banks trimmed their exposure to Greece, Portugal and Spain in the three months to March. The top creditors to Greece and Spain—French and German banks, respectively—cut their lending in the countries by double-digit percentages in the first three months of the year. Meanwhile, in a show of southern European solidarity, Portuguese banks increased their exposure to Greek borrowers by 20%.
A Reuters story suggests that German government officials are taking steps to “identify speculators in Greek debt to try to prevent them from profiting unduly from any bailout.” The measures that could be taken to prevent such profits are unclear, and the article somewhat conflates investors in sovereign debt with those who invest in credit default swaps linked to sovereign debt.
If the purported goal of the investigation is to crack down on CDS speculators, new data from the Bank for International Settlements should give officials pause. In its latest quarterly banking review, published today, the organisation notes that the net exposure of investors to the sovereign CDS of beleaguered euro area economies is a tiny fraction of the actual sovereign debt of those countries. Thus, assuming CDS traders are largely to blame for pushing up the cost of countries’ refinancing is a rather heroic assumption.
Concerns about derivatives markets’ growing influence over the underlying securities upon which they are based have been around for a while. In the context of CDS, these concerns generally surface when a scarcity of corporate debt threatens the settlement of linked derivatives during credit events (defaults, restructurings and the like). But the notional amount of CDS written on sovereign issues pales in comparison to the value of the underlying debt, so attacking derivatives “speculators” on this front seems misguided.
What’s more, a recent Moody’s report suggests that banks may be buying more protection against sovereign default by Greece, Portugal and other teetering economies for reasons not directly related to growing worries about sovereign default. Derivatives linked to some corporate and sub-sovereign borrowers may not exist, so lenders choose instead to buy “protection on the sovereign on the assumption (hope?) of strong correlation between it and the entity to which they have the long credit exposure,” Moody’s writes. Of course, such correlation could be spurious, leaving banks with imperfect hedges and government officials with misguided conspiracy theories.