Monday, November 22, 2010

European bank shares fell again on Monday as news of an €80bn-€90bn bail-out for Ireland failed to ease fears of a deepening sovereign debt crisis across the eurozone.

Politicians in Portugal, Spain and the UK have been at pains in recent weeks to distinguish the challenges facing their domestic banking industries from the catastrophic losses suffered by Ireland’s leading lenders amid the fallout from a property-fuelled boom-and-bust.

EDITOR’S CHOICEBail-out seen as ‘backstop’ for troubled banks - Nov-22.Spanish banks eye wholesale expansion - Nov-22.In depth: European banks - Nov-16.. But they have yet to dispel concerns about the exposure of Europe’s highly interdependent banking system to Irish debt, as well as the risk of a liquidity crisis among European lenders that are still unable to wean themselves off central bank funding.

European institutions hold nearly $509bn of Irish exposure, according to the most recent figures from the Bank for International Settlements. Britain’s share of that exposure is about $150bn – 7 per cent of national gross domestic product – while Germany’s stands at $140bn.

Pan-European “stress” tests carried out in July by the Committee of European Banking Supervisors were aimed at reassuring investors that lenders in highly indebted eurozone economies were being transparent about their exposure to bad debts, as well as their immediate capital needs.

Four months later those tests – which saw only five Spanish banks, one Greek and one German lender “fail” – seem more than partially discredited as Ireland’s banking system is fundamentally restructured and investors turn their attention to Portugal as the next potential domino to fall.

Portuguese ministers have repeatedly sought to reassure investors that Lisbon will not need a financial rescue, casting the banking sector as a positive asset that sets the country apart.

As well as “resilient and well capitalised”, Portuguese banks were “modern, sophisticated, well regulated and supervised”, Fernando Teixeira dos Santos, finance minister, said on Monday.

He failed to mention that normal interbank funding had virtually dried up for them since Portugal’s sovereign debt rating was downgraded in April.

Frozen out of the capital markets, Portuguese banks have been relying heavily on European Central Bank funding, borrowing just over €40bn in October. This was down slightly from a peak of €49.12bn in August, but much higher than monthly rates of €10bn-€15bn before the Greek sovereign debt crisis in May.

Spanish banks remain dependent on wholesale finance from abroad – an avenue that was briefly closed off in the early summer as the eurozone crisis deepened, leaving some relying on the ECB as the only source of liquidity – and vulnerable to the effects of economic stagnation in Spain itself.

Bad loans as a proportion of total assets have in recent months stabilised at about 5.5 per cent of assets, but some analysts believe that the figures are flattered by the banks having taken property assets and equity stakes in developers on to their books rather than admitting that the loans are bad.

The Bank of Spain, the Spanish regulator, has made some strides in restructuring the sector by pushing through a plan for a radical reform of the regional savings banks, known as cajas, through mergers, staff cuts and branch closures – with the help of €15bn from the country’s Fund for Orderly Bank Restructuring and a deposit guarantee fund.

But central bank officials are frustrated by the slow pace of implementation, even as the stock of generic provisions for some lenders is beginning to run dry, threatening them with losses in coming months that will erode their capital.

In the UK, where several banks have seen their share prices fall over concerns about their Irish exposure, the restructuring of state-backed lenders such as Royal Bank of Scotland and Lloyds Banking Group is much more advanced.

While the UK’s overall exposure to Ireland may be a significant slice of GDP, the exposure of individual banks remains manageable, most analysts say.

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