Moody's Warns Of European Bank 'Contagion'
Monday, May 10, 2010

Moody’s, the credit rating agency, has warned that European banks may be caught up in the “contagion” coming out of the Greek debt crisis, and that European banking systems may be threatened if other European governments showed an inability to honour their debts.

The first element to this analysis arises out of the significant Greek credit risk lying within European bank financial accounts. Nevertheless, while Greek exposure is heaviest within the German and French banks, they have been quick to publicize their total credit exposure to that country and to emphasize the manageability of those totals within their balance sheets.

The second threat, however, is that other heavily-indebted European countries – Portugal, Spain and Italy, in that order, and, at the extreme, the United Kingdom (UK) – are caught up in the fall-out from the Greek debt crisis, and their governments’ ability to pay their debts is called into serious question, further deteriorating the value of government debt held by the banks.

Portugal, in particular, has seen the yield on its debts rise rapidly as investors fear that it will fall into the same situation as Greece, in not being able to refinance its bonds, leading to a European Union rescue. It is also suffering as the credit rating agencies are already threatening to downgrade its debts.

At the other end of the spectrum, the risk to the system posed by UK government debt is considered to be minimal as, while the public sector deficit is as large as Greece’s, the level of issued government debt is lower and the rating agencies have said that there is no threat to the UK’s long term ‘AAA’ rating.

However, the risk to all European banks lies not only in the risk of deterioration to their holdings of European country risk assets, but also on whether they will be able to obtain the funding required in the money markets to service those assets if investors think that bank risks are too high or unable to be measured.