BNP Paribas, Société Générale and Commerzbank – a Greek tragedy?

The Franco-Belgian bank Dexia announced on 4 October that it needs to restructure its balance sheet due to Greek sovereign debt exposure. That came as little surprise, especially if you saw our previous theme “Will Greece, the IMF and the ECB figure things out in time?”. Dexia (left out in this analysis) has a total exposure of Euro 22bn to PIIGS and 3.5bn to Greece, according to the European Banking Authority (EBA). Furthermore Deutsche Bank delivered a profit warning also related to a Euro 250m write-down on Greek sovereign debt. These two banks are however far from the most exposed to Greek sovereign debt.

The banks with the greatest exposure to PIIGS sovereign bonds are yet to come clean. The French bank BNP Paribas holds the most debt although Germany’s Commerzbank has the largest engagements in relation to its shareholders’ equity (see chart 1).


Greece is the spark
Does Europe really need to fear a Greek default? From an isolated non-Greek perspective, not really since the total exposure to Greece is limited in a pan-European perspective. Greece is expected to default, either in an orderly fashion or in chaos. The largest risks lie within the system-critical banks which hold additional PIIGS debt, excluding Greece. BNP Paribas has an additional Euro 32bn in non-Greek PIIGS sovereign debt exposure and the corresponding number for Commerzbank is Euro 14bn.

Italy is the key
The largest risk by far is in Italian government debt. Earlier this week Moody’s downgraded its credit rating on Italy and the pressure is immense. The largest holders of Italian government debt are unsurprisingly Italian banks, primarily Intesa Sanpaolo and Unicredit which hold Euro 29bn and 24bn respectively (see chart 2). However, BNP Paribas holds in excess of Euro 12bn in Italian government bonds and French financial institutions collectively are believed to have exposure to Italy amounting to about 20 percent of Italian GDP.

Plausible outcomes and who will pay?
Mismanagement of this crisis will lead to extensive collateral damage and there are no winners in this process. The EBA estimates a capital shortfall of Euro 200bn in the European banking system. This number should be viewed with caution however, given the fact that the EBA has been in charge of the past lax stress tests of Europe’s banks so it might be higher. The banks’ investments in sovereign bonds are not an investment decision but rather a liquidity decision. One has to understand that government bond holdings are an integral part of banks’ balance sheets - see the theme “Banking time bomb…”. So, if sovereign bonds go from “no risk” to “risk” we are looking at a regime shift in the balance sheet composition of all financial institutions and large capital increases will be required. This will inevitably mean that all capital requirement discussions will be obsolete and banking sector regulators will have to go back to the drawing board in Basel. A joint global bank recapitalisation programme looks more likely for each day that passes.