Eurozone infection spreads to banks

AS LEADERS of the European Union (EU) were struggling this week to get parliamentary approvals to expand the bailout fund for heavily indebted member countries, the banking system moved to the centre of the region's debt crisis.

French banks in particular which are heavily exposed to a potential Greek debt default, suffered massive losses on their stocks before two of them - Societe Generale and Credit Agricole - were downgraded by Moody's Investors Service.

To relief the pressure on European banks that face liquidity problems as nervousness about their exposure to Greek debt spread, the leaders of Germany and France publicly pledged that Greece would not be allowed to default.

This seemed to calm the fears that had pushed down the stocks of the three leading French banks - the two that were downgraded and BNP Paribas - by double-digit percentages prior to the pledge.

Nonetheless, the uncertainty surrounding the EU's financial system is likely to persist even considering the assurance about Greece.

There is nervousness about the situation of Italy, Portugal and Spain where European banks are also highly exposed to sovereign debt problems which have eroded confidence.

The overall impact is reflected in the fact that since the start of 2011 Deutsche Bank, the largest German bank, has lost more than a third of its share price on European markets.

Societe Generale has been hit even harder, losing two-thirds of its share price. This loss of confidence was highlighted by Moody's, which pointed to the challenges posed to the bank's liquidity and its ability to raise funding in "bank funding markets".

Beyond the problems facing this particular bank, there is the much bigger challenge of the shortage of capital of Europe's banks.

Last week, the managing director of the IMF, Christine Lagarde, let slip that this undercapitalisation could be as high as US$273.2 billion, which sharply contradicts previous assurances that the leading banks were adequately capitalised.

This revelation is believed to have been a factor in the assault on the banks' shares, because the official position prior to this admission was that only a handful of European banks were suspect.

Just a few months ago, 91 banks were subjected to stress tests which showed that only eight were capital deficient and none of them were French.

Thus, European central bankers kept insisting that all was well while delaying action to repair the system.

The suspicion now is that Europe's stress tests of its banks were less than rigorous and this is adding to the nervousness in the markets.

In the US, stronger stress tests and regulatory action resulted in the injection of capital in banks, guaranteeing of debt and introduction of increased capital requirements. It may be said, therefore, that the EU is still to take corrective action to deal with the financial crisis of 2008-2009.

As financial markets remain tense, European banks are seriously undercapitalised and European governments are bogged down by tedious decision-making processes, the risks of another financial crisis are elevated.

With financial systems around the world being highly interconnected, Europe's woes are a major threat to the global economy and its effects are already being felt in the United States, etc.

As World Bank president Robert Zoellick warned on Wednesday: "The global economy has entered a new danger zone with little running room as European countries resist difficult truths about the common responsibilities of a common currency." Zoellick said the United States, Europe and Japan have "procrastinated for too long on taking the difficult decisions" to fix problems in their economies.

Reflecting these concerns, major central banks around the world moved yesterday to open up new lines of credit to European financial institutions, and the European Central Bank stated that it would allow European banks to borrow dollars for up to three months instead of the current one week, acting in coordination with US Federal Reserve, Bank of England and Bank of Japan and the Swiss National Bank.

It is no doubt this reality that has prompted the recent indication from Chinese Prime Minister Wen Jiaboa that China would be willing to "give a helping".

Europe is not only the largest economic bloc, but China's biggest trading partner and a financial meltdown in the region would have grave consequences.

The Caribbean is itself heavily dependent on Europe as a source of capital, tourists and overall trade. We must, therefore, keep a close eye on developments happening there.

business@gleanerjm.com