Some benefit from fears about sovereign debt

While investors focus on their new obsession with sovereign risk and markets grapple with the prospect of some form of sovereign debt rescheduling in Europe, European bank stocks sank by close to 12% in the first six weeks of 2010.

As fear mounted that the contagion could spread from Greece to larger economies with high budget and/or current account deficits and high personal and corporate leverage, notably Spain and also the UK, analysts painted a bleak picture of the impact on banks from direct losses on government bond holdings – which account for on average 5% of bank’s total assets across Europe – as well as from higher funding costs and worsening asset quality if doubts about sovereign debt sustainability derail economic recovery.