Yesterday we saw the first Financial Policy Committee Report from the Bank of England, as the new regulator of banks awaiting full hand over from the FSA.
Their first instruction to the FSA is:
“The Committee advises the FSA to ensure that improved disclosure of sovereign and banking sector exposures by major UK banks becomes a permanent part of their reporting framework”
The explanation for this requirement is
“Sovereign and banking strains are the most material and immediate threat. Market concerns remain over fiscal positions in a number of Euro area countries and the potential for contagion to banking systems. Any associated disruption to bank funding markets could spill over the UK banks”
If you read on into the Report one of their charts tells us the horror story. It shows that markets think there is an 80% probability of Greek government debt default within the next five years, a 50% chance of a Portuguese government debt default, and a 45% probability of an Irish default. The Bank rightly points out that the amount of dangerous government debt owned by the main UK banks is under good control. Their implied conclusion is UK banks will be fine even if there is a default of one or two of the smaller Euro governments. The only danger is a third round effect, if there is a drying up of wholesale finance to continental banks who lose more on dodgy sovereigns, which in turn could start to disrupt wholesale funding to banks in general.
However, they also say that “since 2008 major UK banks have increased their holdings of global government debt securities from 5.9% to 9.6% of total assets. ” They rightly warn that government bond yields, currently very low in advanced country markets, “could..be susceptible to a reversion towards more typical levels”. This means that there is a risk of capital losses on government bonds even where those bonds are in no danger of default. It is true they can be held to repayment in which case the bank gets all its money back.
The bottom line is the UK is not badly exposed to the Euro crisis. The biggest risk would come if the UK government lent lots of money to troubled countries which it subsequently lost.It is reassuring that Mr Cameron has kept us out of the second as well as the first Greek rescue package, as the UK state cannot afford losses on Euro bail outs. Now the Uk government needs to tell the IMF to be careful with our money as well.