Here's What's In That Brand New Report On Banks And Sovereign Debt

Slideshow of Doom 1

Photo: Sequoia Capital

Banks in the Eurozone face some huge threats.That’s the implication of a new report from the Bank of International Settlements, which devised a chilling analysis of why the economic situation in Europe is quickly going from bad to worse.

The study analyses the impact of sovereign risk on banks, in part based on data taken from the last few years.

The bottom line: As goes the country, so goes the banking system.

These graphs may be pretty, but the situation is not.

Exposure to the domestic sovereign.

Clearly, if banks headquartered in a country hold a lot of domestic sovereign debt, they're going to feel the pain. The report's authors note that banks will likely hold less domestic debt in the future.

Notice, however, that even in 2010 Irish banks held little public sector debt.

Source: BIS

Exposure to foreign debt.

Again, not really surprising. Check out who holds PIGS debt.

Source: BIS

Sovereign credit downgrades almost always entail a bank downgrade.

In seven non-AAA European countries, only 2% of domestic rated banks (3 out of 172) had credit ratings higher than their sovereign.

In Greece and Portugal, negative sovereign credit ratings brought down the banks. In Ireland, this occurred vice versa.

Source: BIS

If the government can't be counted on to ensure bonds, investment will be more costly.

The spread between government-guaranteed and non-guaranteed bonds tightened significantly for Spanish and Irish banks. In countries with more stable debt (US, UK, Germany, and France) spreads remained differentiated.

Source: BIS

Interbank exposures mean that even otherwise healthy banks are going to get roped the crisis. Contagion, anyone?

They're all interconnected...

Investors get skittish.

This drives up risk premia and reduces banks' liquidity.

Talk about herd mentality.

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