More of the eurozone drawn into bank crisis
Spanish bank stability risk has invariably increased in the light of the need for a bailout, but Euromoney’s Country Risk Survey indicates that there has also been an increase in bank risk for all 17 eurozone countries, notably Slovenia and, more recently, France. The trend rise in bank risk highlights the vulnerabilities of an increasingly sophisticated and integrated regional financial system, characterized by cross-border ownership structures.
The latest results from Euromoney’s Country Risk Survey reveal a 0.1 point fall in the average eurozone bank stability score since January, to 6.0, and a 1.2 point drop compared with two years ago. All 17 eurozone participants have seen increased bank risk compared with 2010, but the risks for some countries – Finland, Austria, Estonia, Portugal and Ireland – have stabilized this year; some are considered safe (such as Finland); and others have already received bailouts.
More than 400 economists and country risk experts from a range of financial and other institutions take part in Euromoney’s Country Risk Survey. They evaluate the risks faced by international investors in 186 markets, scoring countries across a range of political, economic and structural criteria. The ECR survey combines these contributor assessments with other data regarding access to capital, credit ratings and debt, to formulate an overall score out of 100 (where 100 is the least risky and 0 the most). Sovereign instability and bank instability seem to go hand-in-hand ECR’s bank stability indicator is one of five economic assessment sub-factors in the survey, and seeks to measure a country’s banking strength. Each of ECR’s country experts quantifies bank stability, awarding a score ranging from 10, which typifies a perfectly functioning system, where all possible exposures are comfortably covered, to zero, where a systemic breakdown in the banking system has occurred. The eurozone scores, shown in the table (above), indicate that all 17 member states have experienced increased risk, but to varying degrees. There is certainly a connection between ECR bank stability scores and government debt; high scores are associated with low levels of debt, and vice versa, albeit with some exceptions (as the chart, below, depicts). Finland, Luxembourg and Slovakia, the three countries with the highest bank stability scores, also have low levels of debt (below the EU’s 60% of GDP limit). Greece, Ireland, Portugal and Italy, those eurozone sovereigns with the lowest bank stability scores, all have triple-digit public debt ratios.
The correlation is similar between ECR’s bank stability scores and scores for the government finances sub-factor (see table below). A higher bank stability score is generally linked to a higher score for government finances.
The link between sovereign debt and bank stability is explained further in an article by Michael Davies and Tim Ng (The rise of sovereign credit risk: implications for financial stability) in the December 2011 BIS Quarterly Review. The authors state that “deterioration in sovereign creditworthiness drives up banks’ funding costs and impairs their market access. Moreover, due to the extensive role of government securities in the financial system, banks cannot fully insulate themselves from higher sovereign risk by changing their operations.” They describe how deterioration in the credit rating of a “home sovereign” – the country in which a bank is headquartered – is manifested in a rise in the banks’ credit default spreads (the cost of insuring against a debt default), a fall in short-term debt issuance and a drain on deposits. Four channels are identified by which sovereign risk affects banks’ funding: losses on sovereign holdings, lower collateral values for wholesale and central bank funding, reduced funding benefits from government guarantees and depressed credit ratings.
Diverging eurozone bank stability scores The dispersion of ECR’s bank stability scores (the difference between the highest and lowest scores) provides an important gauge of risk. It increased from 4.0 in September 2010 to 5.7 in June 2012 – a total of 1.7 points. Omitting Greece, Ireland and Portugal – the three countries that have already received sovereign bailouts – the widening of the differential is three points. It highlights, of course, the problems in Spain. Against the backdrop of a €100 billion bank bailout, its bank stability score has fallen by 1.7 points over the past two years, and by 0.5 points since January, making it now the third-riskiest banking system in the region behind Greece and Ireland. Spain may not have the public debt problems seen in the “bailed-out three”, but its banks are nevertheless in immediate danger.
That much is known. But there have also been large falls in bank stability scores – increased risk – for other eurozone participants over the first half of this year, most of all for Slovenia and France. The Netherlands and Luxembourg, too, have seen comparatively large falls, yet their scores are still high, suggesting that their banking systems are more secure. ECR scores appear to provide more value than data on bank claims as a percentage of GDP. Luxembourg has the highest ratio of bank claims anywhere in the eurozone (see table, below) – reflecting its tiny size, but large financial sector, yet it is regarded as comparatively safe. The opposite is true of Greece and Spain.
French banking sector risk is growing The problems in Spain and Italy may have shifted the eurozone crash spot away from France lately, but French banks are inextricably caught in the headlights. It is a development that hasn’t gone unnoticed among ECR contributors. After Slovenia and Spain, the French bank stability score is one of the largest fallers since January, contrasting with the picture of relative serenity portrayed by CDS spreads for the major operators, ignoring Dexia, the joint French/Belgian owned operator that also trades in Luxembourg, which was badly affected by the 2008 crisis, requiring a €6 billion bailout and which had a CDS spread of 903 basis points as of July 30.
Data supplied by Markit, the financial information services company, shown in the table (below), indicate that the differences in credit default swaps are broadly commensurate with ECR scores. CDS spreads for Italian and Spanish banks are generally more elevated than for Germany and have worsened since January in certain cases, in spite of a tightening of spreads in recent days due to increased confidence in the eurozone resolution plan following supportive comments by European leaders.
Cyprus and Belgium may be considered riskier, overall, from a bank stability perspective, but the trend decline in France’s indicator highlights another worrying feature of the eurozone crisis – French exposure to Italy and Spain. The latest, end-March, preliminary consolidated banking statistics from the Bank for International Settlements (BIS) indicate that France has the largest proportion of short-term bank lending (of up to one-year maturity), comprising almost 60% of its total bank claims. The French banking system is also the most exposed to other banking sectors. Nearly 61% of its bank lending is to other banks, which is by far the largest proportion of any eurozone country. Moreover, France is acutely exposed to Italy and, to a lesser degree, Spain. French claims on Italy, amounting to 46% of that country’s total foreign claims, comprise 29% of bank lending and 55% of all non-bank private-sector lending to Italy, making France hugely implicated in any Italian crisis. The figures are compiled on an “ultimate risk” basis, taking into account where the claims are underwritten (the risk source), rather than just the source of the bank actually doing the lending – an important distinction. France is also more exposed to Belgium and Greece than other major sovereigns.
With French sovereign debt already at almost 86% of GDP at end-2011, according to Eurostat, and expected to climb further in the short term as the new Socialist government grapples with a bloated budget deficit, not to mention the fact that French growth prospects are diminishing, banking risk in France is becoming a real issue in spite of reports that the banks are cutting back on their lending abroad. It is something, perhaps, which is showing up on ECR’s radar, but which CDS spreads are not necessarily highlighting. CDS spreads for the three largest French banks (ignoring Dexia), ranging from 233 basis points to 283bp, are not only similar to three of the large US banks: Bank of America, Citigroup and Goldman Sachs, which range between 242 and 259bp but, at least for BNP and SocGen, have also tightened since January. This may reflect the reduced lending abroad as the banks attempt to preserve capital and minimize their foreign exposures, but is probably also an enthusiastic response to eurozone recovery plans.
Yet as Victoire de Groote, global head of country risk at HSBC, and one of ECR’s French contributors, states: “Italy is the main risk to French banks and BNP is the most exposed French bank to Italy.
“It is very difficult for French banks to raise capital in the case of an Italian bailout. In a worst case scenario French banks would need to be assisted by the ESM fund. The sovereign would not be able to manage the scale of the banking sector alone.”
According to, Lorenzo Naranjo, assistant professor at the ESSEC Business School, and another of ECR’s French contributors: “The threat for French banks is more on the cash flow side than an asset-based problem – interest rates are still low and the banks are still competitive. It is more dangerous to lose clients and business than to have assets on your balance sheet that are not so good.”
Slovenia: the next banking system bailout?Slovenia, on a bank stability score of 6.2 in January, and at the time considered safer than Cyprus or Belgium, has suffered a 0.6 point fall over the past six months (to 5.6), making it the next “at risk” eurozone sovereign. Two years ago the Slovenian banking system was regarded as the third safest in the region – just behind Finland and Luxembourg. The state-owned Nova Ljublanska Banka – Slovenia’s largest bank – is believed to require a cash injection of €500 million by the end of this year. The second and third largest – Nova KBM (also state-owned) and Abanka Vipa (partially so) – require €150 million in total to cover their loan-losses. This comes at a time of extreme economic weakness and pressure on the government’s finances.
The latest forecasts from the Organization for Economic Cooperation and Development suggest that Slovenia’s real GDP will decline – by 2% in 2012 – and, for the third consecutive year, by 0.4% in 2013. As a result of fiscal consolidation the general government deficit, which increased to 6.4% of GDP last year, is predicted to fall to 3.9% in 2012 and 3% in 2013. Even if those figures are not blown off course by the lack of growth, it won’t stop the general government debt burden from rising to 63.2% of GDP in 2013, compared with 44.3% in 2009, according to the OECD.
Ales Pustovrh, Managing Director at Bogatin, an academic think-tank in Slovenia, and one of ECR’s contributors, states: “Slovenian banks do not have any direct contagion risk to Italy. The banks are still making profit, and in theory they could of course increase their capital through profit, but this would be over the long term. So there is a likelihood of a rescue of a few large domestic banks owned by the government.
“The riskiest exposures involve two groups of loans: 1. real estate development companies and construction companies; 2. Financial holdings, used as a vehicle to perform leverage for the country in 2007.”
And what about the region as a whole?Recent movements in ECR scores put the single-currency area on the same average level of bank risk with the Brics (see chart, below). It means that the eurozone is still considered a safer bet than most other parts of the world, with the exception of North America. But the eurozone has also seen one of the largest falls in its average score since September 2010. The score differential to North America has consequently widened from 0.9 to 1.2 over the past couple of years, and even more interestingly the differential to Latin America has narrowed from 1.4 to 0.6. If this trend continues LatAm would for the first time have a “safer” banking system than the eurozone – something to keep an eye on over the coming months.
This article was orginially published by Euromoney Country Risk
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| Source: ECR |
More than 400 economists and country risk experts from a range of financial and other institutions take part in Euromoney’s Country Risk Survey. They evaluate the risks faced by international investors in 186 markets, scoring countries across a range of political, economic and structural criteria. The ECR survey combines these contributor assessments with other data regarding access to capital, credit ratings and debt, to formulate an overall score out of 100 (where 100 is the least risky and 0 the most). Sovereign instability and bank instability seem to go hand-in-hand ECR’s bank stability indicator is one of five economic assessment sub-factors in the survey, and seeks to measure a country’s banking strength. Each of ECR’s country experts quantifies bank stability, awarding a score ranging from 10, which typifies a perfectly functioning system, where all possible exposures are comfortably covered, to zero, where a systemic breakdown in the banking system has occurred. The eurozone scores, shown in the table (above), indicate that all 17 member states have experienced increased risk, but to varying degrees. There is certainly a connection between ECR bank stability scores and government debt; high scores are associated with low levels of debt, and vice versa, albeit with some exceptions (as the chart, below, depicts). Finland, Luxembourg and Slovakia, the three countries with the highest bank stability scores, also have low levels of debt (below the EU’s 60% of GDP limit). Greece, Ireland, Portugal and Italy, those eurozone sovereigns with the lowest bank stability scores, all have triple-digit public debt ratios.
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| Source: ECR |
The correlation is similar between ECR’s bank stability scores and scores for the government finances sub-factor (see table below). A higher bank stability score is generally linked to a higher score for government finances.
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| Source: ECR |
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| Source: ECR |
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| Source ECR |
Cyprus and Belgium may be considered riskier, overall, from a bank stability perspective, but the trend decline in France’s indicator highlights another worrying feature of the eurozone crisis – French exposure to Italy and Spain. The latest, end-March, preliminary consolidated banking statistics from the Bank for International Settlements (BIS) indicate that France has the largest proportion of short-term bank lending (of up to one-year maturity), comprising almost 60% of its total bank claims. The French banking system is also the most exposed to other banking sectors. Nearly 61% of its bank lending is to other banks, which is by far the largest proportion of any eurozone country. Moreover, France is acutely exposed to Italy and, to a lesser degree, Spain. French claims on Italy, amounting to 46% of that country’s total foreign claims, comprise 29% of bank lending and 55% of all non-bank private-sector lending to Italy, making France hugely implicated in any Italian crisis. The figures are compiled on an “ultimate risk” basis, taking into account where the claims are underwritten (the risk source), rather than just the source of the bank actually doing the lending – an important distinction. France is also more exposed to Belgium and Greece than other major sovereigns.
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| Source ECR |
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| Source: ECR |
This article was orginially published by Euromoney Country Risk
