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8 The 2012 guide to GLOBAL RISK TRENDS Eurozone bank stability remains key focus Far from stabilizing, the risks associated with the eurozone debt crisis are still rising and infecting other parts of the world, as banking sector problems deepen and extend their reach Bank stability has become an increasingly dominant factor for counterparties and deposit holders seeking safety. Each of ECR’s country experts is asked to quantify bank stability risk, by awarding a score ranging from 10, typifying a perfectly functioning system where all possible exposures are comfortably covered, to zero, where a systemic breakdown in the banking system has occurred. Interestingly, bank stability and government debt appear to go hand in hand. High scores are correlated with low levels of debt and vice versa, with some exceptions. Finland, Luxembourg and Slovakia, the three countries with the highest bank stability scores, have low levels of debt (below the EU’s 60% of GDP limit). Greece, Ireland, Portugal and Italy, those eurozone sovereigns with the lowest bank stability scores, all have triple-digit public debt ratios. The correlation is similar for bank stability and another of ECR’s surveyed indicators, government finances. A higher bank stability score is generally linked to a higher score for government finances, while the opposite is also true. This link between sovereign debt and bank stability is explained in an article by Michael Davies and Tim Ng, ‘The rise Eurostat 180 160 140 120 100 80 60 40 20 0 General Government Debt, % of GDP (y-axis) vs ECR Bank Stability Scores (x-axis) Source: Euromoney Country Risk; Eurostat 0 1 2 3 4 5 6 7 8 9 10
The 2012 guide to GLOBAL RISK TRENDS 9 of sovereign credit risk: implications for financial stability’, in the December 2011 Bank for International Settlements (BIS) Quarterly Review. The authors describe how “deterioration in sovereign creditworthiness drives up banks’ funding costs and impairs their market access. Moreover, due to the extensive role of government securities in the financial system, banks cannot fully insulate themselves from higher sovereign risk by changing their operations.” With Spain acknowledging it will require a €100 billion bank bail-out, Italy also edging toward default, and wider fears over sovereign debt dynamics as many countries fail to find the recipe for economic growth, the health of the region’s financial system continues to cause alarm. All 17 eurozone sovereigns have succumbed to increased bank stability risk this year, perpetuating the trend decline. There is nonetheless considerable variation among member states. Spain’s bank stability 10 9 8 7 6 5 4 3 2 1 0 ECR Government Finances Scores (y-axis) vs Bank Stability Scores (x-axis) Source: Euromoney Country Risk 0 1 2 3 4 5 6 7 8 9 10 Davies and Ng further explain how deterioration in a ‘home sovereign’ credit rating - the country in which a bank is headquartered – is revealed in a rise in the banks’ credit default spreads (the cost of insuring against a debt default), a fall in short-term debt issuance and a drain on deposits. Four channels are identified by which sovereign risk affects banks’ funding: losses on sovereign holdings, lower collateral values for wholesale and central bank funding, reduced funding benefits from government guarantees and depressed credit ratings. score has fallen aggressively, of course, and it is now the third riskiest banking system in the region behind Greece and Ireland. There have also been large falls in bank stability scores for other eurozone participants. An erosion of confidence in the banking systems in Luxembourg and the Netherlands is particularly noteworthy. However, both countries can still boast high scores in comparison with other parts of the eurozone - especially Luxembourg, which is considered to have the safest banking system bar rock-solid Finland, an indication that it still offers considerable security for counterparties and deposit-
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