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Sovereign debt crisis is a bank debt crisis too

Banks and their sovereigns are joined at the hip. It’s a toxic embrace.

It’s the sovereign, stupid

Sometimes you just can’t do anything right. European banks have spent the three years since Lehman collapsed working on their balance sheets: raising capital ratios, improving risk management and liquidity management, hacking away at their loan-to-deposit ratios and reducing their reliance on interbank funding. And where has this got them? Absolutely nowhere.

The funding environment for European banks could hardly be bleaker. In August they issued just €2.7 billion – the lowest figure since December 1992, according to Citi. The iTraxx senior financials index hit a record high of 254 basis points in the last week of August, there having been practically no issuance from peripheral banks throughout the previous three months. And to cap it all one eurozone bank was forced to tap the European Central Bank in dollars when US money-market appetite for this risk dried up as well.

The reason for this is not rocket science – it is the sovereigns, stupid. No sector is more closely correlated to the sovereign than FIG or more harshly exposed to deteriorating domestic conditions. And investors either can’t or won’t look past sovereign concerns when assessing their appetite to fund many banks.

For a sector that has put so much effort into improving its capital ratios this is enormously frustrating.

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