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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
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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-