Vol 2 No.

43 January 09, 2012

developments that matter in financial markets

European Banking Crisis

You could have a significant slowdown in several parts of the world. Global growth is decelerating, and uncertainty has risen. At the same time, we have laid a lot of groundwork for a better functioning of economic union in the future and we should draw confidence from that. Mario Draghi, President, European Central Bank

Introduction
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The banking sector in the euro zone has come under acute stress in recent months due to its exposure to sovereign debts. Funding pressures have caused a spike in the three-month Euro Interbank Offer Rate (Euribor), which is now almost one percent above the three-month overnight index swap. Against the background of soaring counterparty risk, euro zone banks deposits in the European Central Bank (ECB) have surged to over 340 billion.

Long-Term Rating Downgrade of Top Euro Zone Banks

Number of Ratio to Total assets of Ratio to total banks down- rated banks downgraded assets of rated graded (%) banks ($ bn) banks (%) Austria 1 25.0 275 34.2 Belgium 6 100.0 2,560 100.0 Finland 2 100.0 494 100.0 France 13 61.9 11,935 76.7 Germany 17 65.4 7,609 64.7 Greece 4 100.0 444 100.0 Ireland 6 100.0 1,285 100.0 Italy 10 100.0 3,603 100.0 Netherland 6 75.0 4,341 90.6 Portugal 2 100.0 302 100.0 Spain 10 76.9 3,859 87.2
Source: Bankscope

Country

Impact of Sovereign Default

The heavily exposed euro zone banking system could suffer dramatically as a result of any sovereign default. Many European banksespecially French and German bankshold large amounts of sovereign debts of countries such as Greece, Ireland, Italy, Portugal, Spain, etc. These exposures are potentially larger if one includes financial derivatives such as credit default swaps (CDS).

Debt Exposure (in $ million, as of June 2011)

Public Sector Borrowings Greece Ireland Italy Portugal Spain
Source: BIS

European Central Bank

Lender: British Banks 3,251 3,709 17,430 1,859 7,638

Lender: French Banks 10,686 2,896 106,764 6,153 30,492

Lender: German Banks 12,411 3,470 47,624 8,978 29,454

As funding markets have dried up, banks have become increasingly dependent on the ECB. Banks in the four smaller peripheral countriesGreece, Ireland, Portugal and Spainhave now borrowed 380 billion from the ECB in loans. In Greece, these loans are now funding almost a quarter of the banking systems assets. And this problem has spread beyond this group of countries to Italy and France, where the use of loans from the ECB has skyrocketed in recent months with banks in the two countries now owing around 150 billion each. Against this background, there is a serious risk of significant bank failures. In 2011, Franco-Belgian bank Dexia failed as its short-term creditors pulled funding and this pattern could easily be repeated.

Many Banks Downgraded

ECB Steps to Overcome the Crisis

Forthcoming Programme

MCX CERTIFIED COMMODITY PROFESSIONAL (MCCP)

January 30 - February 8, 2012 Venue: Mumbai

Worries over the health of Europes banks have led to downgrading of many banks. A widening sovereign debt crisis would bring large losses for banks, eroding their capital base. With many European banks already facing capital shortfalls, there is urgency in raising new capital. However, with low investor confidence, it will be difficult and costly to raise the amounts required. Therefore, banks may be forced to shrink their assets by reducing lending. This would reduce business lending, stunting economic growth. In a worst case scenario, the deteriorating health of the euro zone economy and large losses on sovereign debt could lead to bank failures. This could, in turn, lead to panic and a lending freeze.

Three-year refinancing operations to support the supply of credit to the euro area economy. These measures address the risk that persistent financial markets tensions could affect the capacity of euro area banks to obtain refinancing over longer periods. All refinancing operations until at least the first half of 2012 and all liquidity demands by banks would be fully allotted at fixed rate. A new Covered Bond Purchase Programme of 40 billion. Funding in the US dollar is facilitated by lowering the pricing on the temporary US dollar liquidity swap arrangements.

For details, contact: Bhairavee Redkar Mobile: +91 9930267955 Email: bhairavee.redkar@ftkmc.com Giridhari Kawadker Mobile: +91 9930267985 Email: giridhari.kawadker@ftkmc.com

Strong Measures Required

Euro zone banks need to roll over some 600 billion of wholesale financing in 2012, which could prove very difficult in the current market conditions. A worsening outflow of bank deposits could completely undermine national banking systems, crashing the real economy in the process. Contributed by M Ravindran
January 15-29, 2012 Mumbai, India

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Disclaimer: This Newsletter is prepared to enhance awareness and for information only. The information is taken from sources believed to be reliable but is not guaranteed by FTKMC as to its accuracy. The contents are not meant for taking decisions of any strategic nature or for investments, for which FTKMC will not be responsible.