Just a very quick note.
Moodys just downgraded 26 Italian banks. I don’t think these will be the last. In fact I wonder if the extent of the downgrades that will flow from any Greek default and certainly from any further defiance in Spain has really been priced in by the banks. I tend to think they have not priced it in and might be taken by surprise at how many banks, which banks and in what countries the downgrades happen.
Just as the ratings agencies factor in to bank ratings what they call ‘Sovereign Uplift’ (For those who want to know what Sovereign Uplift is and what the Rating Agencies actually do, I have written Lair’s Lexicon primer on Sovereign Uplift ) – which means the amount of support they feel a bank can expect form its sovereign by way of bailing out – so I think that behind Sovereign uplift there is also what we might call Systemic Uplift.
That is, whether the ratings agencies make it explicit or not – I think there must be a line somewhere in their calculations which looks at the amount of support that Sovereigns can expect from the Central bank of whatever monetary system they are part of. For US banks Sovereign and systemic are obviously the same. They both come from the Fed. But for European banks they are not identical. Each Sovereign has its own Central bank but above and behind them, supporting them albeit indirectly, is the ECB.
All European banks benefit from some degree of Sovereign Uplift on their ratings. UK banks have, over recent years, benefited from as much as 5 grades. That is, their rating grade was up to 5 levels higher when BoE support fore the banks was factored in, than it would have been if the rating agency had looked at the strengths of the UK banks in isolation. But the ratings agencies looked at how much support they thought the BoE would give to the banks in time of need and this consideration boosted the rating and perceived ‘robustness’ of the UK’s banks by up to 5 grades. It is less now.
I think it is one of the unspoken or at least little talked about consequences of any country leaving the Euro, that this dents the credibility of the ECN’s implicit promise to stand behind any of its member nations. If the ECB runs up the white flag on this ‘absolute’ guarantee, then the guarantee is no longer AAA rated for any of the other nations that are struggling under and even threatening to throw off, their yoke of austerity and debt.
I wonder if this formed part of the reasoning for the downgrades in Italy. If the Central bank of Italy is thought to have the 100% unquestioning support of the ECB behind it, that is a far more solid proposition than the Central bank of Italy without ECB support. All it takes is for the world to perceive that the ECB might not stand behind a sovereign’s central bank – may not be able to – and the calculation of support that that central bank can in its turn offer its nations banks, changes. Basically I’m wondering if the ECB’s credibility as the ultimate guarantor of solvency and systemic invulnerability has finally wearing thin. Perhaps the Eurocrats don’t realize that their reserves of authority and credibility have been exhausted.
What this means is the ratings agencies must re-evaluate how robust many banks are now or at least soon, and before any actual event occurs in a nation. Thus nations and their banks, in nations that are not yet perceived to be in the firing line directly, may find their banks being fingered for downgrades without any apparent cause. If so then the ripples from Greece and perhaps Spain also will spread faster, sooner and wider than I think the banks and authorities might be expecting.
I would expects banks in Portugal, Spain, Belgium, Ireland, France and some even in Germany and Holland to be quietly put on the list for review. UK’s banks might be looked at for their exposire to Spain.
OR I could be quite wrong. This is pure speculation. I would be interested to know what others think.