Like avian flu Eurozone contagion could be on us before we know it
ON THURSDAY we finally saw what contagion could look like. After large deposit withdrawals from Greek lenders earlier this week, Spanish newspapers reported that one of Spain’s banks was facing similar problems, although it later denied this. Contagion was only meant to happen when Greece actually left – or was kicked out – of the Eurozone, but could it happen for real this quickly?
The trouble with bank runs is that they become almost airborne and can be the financial equivalent of bird-flu. When depositors withdraw their funds from banks it shows a complete lack of confidence in the financial system. Spain’s banks are loaded with bad real estate loans, which are expected to rise in the coming weeks and months. The government has made attempts to re-capitalise the banking sector, the latest one just last week. But the problem could be bigger than the government has estimated and may even push Spain towards a bailout.
Spanish savers can see what is going on in Athens, thus it is easy to understand why they might want to withdraw their money to the safety of a secure Swiss vault. Greek banks’ balance sheets were essentially decimated when Athens negotiated the private sector debt swap. The four biggest banks had a combined loss of nearly €30bn (£24.1bn). That is roughly equivalent to the loss faced by Citigroup at the peak of the financial crisis in 2009; however, Greece’s economy is the equivalent of 0.3 per cent of the US economy, which puts things into perspective. In Spain, the problem is even more complex. Recapitalising the banks could push Spain towards a bailout. Yet Spanish banks hold sovereign debt, so if Spain were to undergo a private sector debt haircut a la Greece, the banks would require even more support from European officials as the value of Spanish sovereign debt plummeted.
The Greeks may be withdrawing money at a faster rate now; however there has been a steady flow of funds out of Greek banks since 2009. Deposits have fallen by 30 per cent since 2010 at a rate of approximately €5bn per month. Next month’s re-run of the election has only intensified what was already a bad situation as savers fret that a return to the drachma could cause their holdings to decline in value. In Spain, the problem is less severe: deposits in Spanish banks have declined by approximately 5 per cent since 2010, nothing like the scale we have seen in Greece. Added to that there is not yet talk of a return to the peseta, but if the same pattern as Greece emerges in the Iberian nation then the rate of deposit withdrawals could turn into an unsustainable torrent.
The problem is that the currency bloc does not have a “joint” banking sector; in fact the whole currency union was never designed to have one joint economy. The economy of each member state has a banking sector at its heart. And as banks see their deposits drop, their very survival gets called into question. Although banks can borrow from their national central banks if the European Central Bank (ECB) turns them away (as has been the case for some Greek banks recently), in the case of Greece it would fall to the rest of Europe to recapitalise its central bank if it was to need it.
Spain has also become a European concern. One option touted as a way for Spain to avoid a bailout is to recapitalise its banks using the EFSF, the Eurozone’s bailout fund. If this were to happen, it would mean that German taxpayers were on the hook for Spanish banks’ liabilities, which would be the biggest sign yet of a shift to closer economic integration in the currency bloc.
Closer economic, fiscal and political ties in the currency bloc are a possible solution to the sovereign debt crisis. However, German taxpayers are extremely unlikely to want to fund bad mortgages on Spanish banks’ books. If Germany doesn’t play ball then expect a tidal wave of deposit withdrawals from Spanish institutions, causing a new phase of this crisis – more severe than anything we have seen so far.
Kathleen Brooks is research director at Forex.com