After The Not-So-Stressful Stress Tests, Europe Is Stressed18 July, 2011, 19:54. Posted by Zarathustra
Tags: Debt Crisis, Europe, Italy
After announcing the results for the phoney stress tests on European banks which did not give any confidence to investors, now focus is back in European on-going sovereign debt and banking crisis.
As mentioned, the stress tests are a bit of a joke no matter what. If many banks failed, that will scare the hell out of everyone, while too few banks make the stress tests look silly. Of course, as one banking analyst in London told me, no one really care about the official numbers. For instance, the so-called adverse scenario only factors in some 25% valuation cut for Greece debts on trading book, and it has not factored in sovereign default, while Greek debts are already traded at some 50 cents on €1. But they did provide a lot of data that analysts can work with. For instance, they are building up scenario which factors in a 60% haircut for Greece and 40% haircut for Ireland and Portugal in the event of sovereign default, and the capital shortfall in such scenario will amount to somewhere between €20-30 billion instead of the official €2.5 billion. Also, the effect of a Greece default would affect domestic banks more than other banks in Europe. In fact, the Greek banking system will collapse if the sovereign default, but, according to this analyst, the impact to the rest of Europe would probably be manageable.
The story though would be whether it will spread to Spain and Italy. As FT Lex column repeatedly said, Italy is okay as far as public finances are concerned. James Mackintosh also points out that excluding interest expense, Italy is actually expected to run a budget surplus this year. So as long as interest rates can stay at a reasonable level, Italy is really okay. But the concern here is really whether the contagion will spread. It is certainly not looking very good today, as Italy 10-year bond yield surges above 6% now despite having passed the austerity budget.
European Banks are certainly mostly falling today. UniCredit and Intesa Sanpaolo are down about 4% in Italy, while Deutsche Bank is down almost 3%. A more interesting and bizarre situation in Europe, as I heard from the London-based analyst, is that the normal Italian interbank market is completely frozen. Normally banks can borrow and lend to each other in the interbank market, but now Italian banks no longer trust each other to point that they need a clearinghouse in between as their counterparties to borrow and lend to each other.
Looks like trouble is still ahead of us.