When a country trades just like its banking system | FT Alphaville

When a country trades just like its banking system

It’s happening in CDS markets.

The below shows Moody’s Analytics’ implied-ratings for countries against those of the countries’ banking systems. You can see that for ‘strong’ sovereigns like Germany, the CDS market’s view of the banking system is pretty far below their sovereign view.

But for weaker sovereigns…

Well, you might as well say a Greek bank is nearly as bad as Greece. Or a Belgian bank is viewed almost like Belgium. Or an Italian bank is just like Italy.

Here’s some comment from Moody’s Analytics’ David Munves:

The market’s negative view of a country implies that it will not have the wherewithal to support its banking system, should the need arise. Portugal, Greece, and Ireland, and potentially Spain, are examples here. This speaks to a country’s ability to help its banks if needed. An additional aspect is that the more difficult the circumstances for the sovereign, the less willing it could be to support its banking system, for at least two important reasons. One is that it could becomes politically unpalatable for the government to do so. The other is that such an action could compete with the sovereign’s own access to the capital markets.

In most cases the sovereigns clustered on the left side of the graph have moderate-sized banking systems in relation to the sovereign’s GDP, indicating that the countries could provide selective support without hurting their credit standing. Switzerland is perhaps an exception here, but such concerns are offset by the sovereign’s extremely strong position, the strong capital position of its banks, as well as the fact that its large banks are really not “Swiss” – that is, both their assets and liabilities lie mostly outside Switzerland. The UK occupies an uncomfortable middle ground: it has an outsized banking system that has experienced problems, and has some challenges at the sovereign level as well.

Sometimes simple explanations are best – in this case, almost all banks are trading cheaply for their ratings due to heightened systemic risk, so big gaps to the strong Aaa countries are inevitable.

And indeed, some banking analysts are expecting banks to “rally hard” (Evolution’s Arturo de Frias) if significant sovereign relief, like an upsized EFSF, were to happen.

But sovereign-bank decoupling in Europe’s periphery certainly is not here yet.

Related link:
Europe’s grim sovereign-bank loop – FT Alphaville