Banks Matter in Eurozone Debt Crisis

Abstract

The eurozone sovereign debt crisis, characterized by enormous debt burdens faced by its weakest economies, has also induced a parallel credit crunch and illiquidity concerns for European banks. Bank holdings of sovereign debt issued by peripheral eurozone countries have dropped in value and are being reclassified from their prior riskless weight assigned by Basel III. Banks are also experiencing serious difficulties in raising new funds from their markets. Default risks and systemic-risk capital shortfalls are delineated for individual banks. Ten European banks are currently among the top 14 global banking institutions ranked by probability of default. Italy’s UniCredit displays the largest five-year default probability (39%), based on spreads of credit default swaps. Eight European banks are included among the top 11 global banks ranked by expected capital shortfalls associated with systemic risk in the next major credit and illiquidity crisis, with Deutsche Bank requiring the largest additional capital ($232 billion). Systemic risk measures over the past five years are delineated for Credit Agricole. The European Central Bank has stepped up low-cost, short-term lending with relaxed collateral demands. Banks optimistically might now be able to meet their short-term funding needs, but it is too soon to discern the impact.