The IMF Explains Why One Shock Could Lead To A Whole New Financial Crisis In Europe

Europe’s banking sector has failed to deleverage in the wake of the financial crisis, and still remains heavily exposed to fringe eurozone debt, according to the latest IMF report.

Banks within the region are now hunting for more cash anyway possible, which includes a fight for savers deposits. This, among other attempts to recapitalize, could cause problems down the road, and fails to address the underlying problems in the system.

From the IMF:

In some countries (for example, Spain and Greece), this has triggered a competition war for retail deposits, putting unsustainable pressures on interest margins. In other countries, covered bonds issuance has picked up, but over-collateralization required even for the best rated banks means that only a limited portion of their balance sheets can be funded in this way. And reliance on ECB funding has become entrenched for a number of second-tier banks in large European countries; nearly all banks in Greece, Ireland, and Portugal; and some small and mid-sized Spanish saving banks. With liquidity pressures remaining acute, a negative shock could rapidly spill over through the periphery and potentially beyond. Despite some reduction during the last year, cross-border exposures creditor countries (Waysand, Ross, and de Guzman, 2010) (Figure 1.9). Hence, the system would still be severely tested if euro area stresses were to intensify.

This story remains mainly about the exposures of Europe’s largest banks to fringe eurozone debt. While in some countries, where banks are still exposed to private sector real estate losses, deleveraging is about writing down bad loans and raising capital, in the eurozone’s core it’s about divesting from risky fringe eurozone debt.

Banks in German and France are unlikely to be able to sell the bonds of Greece, Portugal, and Ireland at market, and so must wait for those bonds to expire or, the ECB to buy them, in order to escape their positions.

Don’t miss: Who would get slammed in a Greek debt restructuring >

Note, German and France’s slight decline in exposure to Greece, Ireland, and Portugal.


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