European leaders may stave off a banking crisis for a few more weeks. Markets may even stage a relief rally as Greek debt worries abate. But make no mistake—a deeper crisis in foreign banks is coming.
Financial markets are behaving as if they expect a European banking crisis that would require the bailout or nationalization of some European banks.
That would feel like a replay of the financial crisis that followed the bankruptcy of Lehman Brothers in the fall of 2008. Only this time, the epicenter would be Europe instead of the United States, and the ripples would expand from the Eurozone outward into global financial markets.
How realistic is that fear? Very, I’m afraid. European banks are facing a very real liquidity and capital crisis that could lead to the need for a government rescue of some globally significant banks.
But the crisis isn’t an exact replay of the 2008 crisis. The effects of the crisis would not be limited to Europe, but the likelihood that a European crisis would take down a major US bank—in a mirror image of the 2008 crisis where problems originating in the United States did lead to the bailouts of banks in the United Kingdom, Germany, and Belgium—is relatively small.
On the other hand, the crisis is potentially worse this time around because the European Central Bank is much less able to intervene as a lender of last resort than the US Federal Reserve was in 2008.
Understanding This Crisis
The current European banking crisis is rooted in the Greek, Italian, Spanish, Portuguese, and Irish debt crises. But the repeated collapse-bailout-collapse-again pattern of the prices of bonds of those countries wouldn’t have produced the current mess without a series of missteps by banks, bank regulators, and central banks.
European banks hold a huge amount of government debt from the countries involved in the crisis. German banks, for example, held $22 billion in Greek government debt at the end of 2010, according to the Bank for International Settlements.
If you add holdings of Greek government debt to holdings of private-sector Greek debt, the exposure gets much higher. For example, in May, Fitch Ratings said that French bank Credit Agricole (CRARY) had $35 billion in exposure to Greek government and private debt. BNP Paribas (BNPQY) and Société Générale (SCGLY) had exposure of about $11 billion each.
The exposure of European banks to Greece, however, is small souvlaki compared with exposure to the much larger Italian economy. BNP Paribas, for example, has an estimated $31 billion in exposure to Italian government and private-sector debt. (more)