At the Wednesday EU summit, leaders put off fleshing out a new rescue package and deferred key decisions, including joint eurozone sovereign bonds and fiscal co-ordination, until June seen as yet another make-or-break euro-group meeting.
This week, German officials described the prospect of a Greek exit from the eurozone as a considerable but manageable risk, in a bid to manage expectations ahead of the June 17 Greek election.
With markets in a tailspin, sharp policy divisions showing no signs of abating, and rumours of deposit outflows from peripheral European banks, market players fear international banks are ill-equipped to deal with the second-order market impact should Greece leave the eurozone even with two years of preparing and stress-testing the scenario.
The banks have understandably not been very explicit about their contingency plans, says Andrew Stimpson, banking analyst at Keefe, Bruyette & Woods.
On the upside, global banks have largely beefed up their capital buffers to achieve a core capital ratio of 9% ahead of the European Banking Authority's (EBA) deadline of June 30. In addition, banks have largely written down the value of Greek bonds, post private sector involvement, and used the long-term refinancing operation to refinance and boost liquidity buffers at their southern Europe divisions.
As a result, for most international lenders save for Société Générale and Crédit Agricole the direct impact of a Greek eurozone exit "should be limited, says Miguel Angel Hernandez, European banking analyst at Barclays Capital.
However, the immediate risk will be a fall in the value of sovereign debt in Portugal, Ireland, Spain and Italy, leaving banks facing large paper losses, with financial institutions in Germany, France and the UK holding some $1.19 trillion of claims in these four sovereigns at the end of 2011, according to Bank for International Settlements data.
Another stark risk is the prospect of deposit outflows from peripheral European banking systems. I have a feeling deposit outflows from peripheral European banks might be the development that convinces policymakers of the seriousness of this crisis," says Stimpson. "But the current market distress more than justifies a new, aggressive pan-EU rescue package.
Deposit outflow game-changer
As Euromoney has reported, the deposit outflow story in Greece is backed up by the official data, with a bleeding of the customer deposit base since end-2009. Deposits in the Spanish banking system in Q1 fell 4.3% year-on-year. Italy, by contrast, has seen deposit inflows, Ireland and Portugal have held steady while the French and Germanic banks have been the big winners, amid a flight to safety.
According to Barclays Capital analysts, the nine largest European banks, under their coverage, report liquidity buffers of more than 1 trillion, some 28% of customer deposits and 16% of their funded assets. These individual liquidity buffers, at face value, are ample but in the event of a systemic loss of depositor confidence triggered by eurozone break-up fears and/or capital controls financial institutions will need multiple European Central Bank lifelines, the analysts conclude.
However, there are no fixed-income instruments such as credit default swaps that allow European banks to hedge currency redenomination risk while banks are largely unable to offload credit exposures in the private placement market without realizing large-scale losses, says Stimpson.
Still, expectation management is the name of the game. Simon Adamson, senior financial institutions analyst at CreditSights, believes if European leaders create a narrative that a Greek exit was an isolated event while crafting a new growth package and fiscal co-ordination plans the contagion could be limited. I dont think a Greece exit itself has the ability to kick off a Lehman-type event, since the financial and economic channels are smaller," he says. "It all depends on the political response.