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Risk to US financial system "not small" [ClearOnMoney]
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Risk to US financial system "not small"

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Commentary

Risk to US financial system "not small"

13 Nov 2011 by Jim Fickett.

Probably no one, including the banks, can predict how bank runs in Europe would affect the rest of the world. But the Institute of International Finance has attempted to estimate exposures, and warns that effects in the US could be serious. Reuters reports:

While the Treasury has been at pains to say that direct U.S. bank exposure to European countries now receiving bailout aid – Greece, Ireland and Portugal – is moderate, once the debt of Italy and Spain, plus credit default swaps, and U.S. bank indirect exposure through European banks are added, the potential sum could exceed $4 trillion.

“As such, the potential for contagion to the U.S. financial system is not small,” the Institute of International Finance, the lobby group for major international banks, said last week.

Hedging and netting would limit the true size of any losses, so the $4 trillion figure would be the outer edge of U.S. total exposure.

U.S. banks had about $180.9 billion of debt from Greece, Ireland, Italy, Portugal and Spain on their books at the end of June, based on Bank for International Settlements data. Italy accounted for the largest chunk, more than $250 billion. Guarantees and credit derivatives added another $586.6 billion, bringing the total to $767.5 billion, the IIF said.

There is a secondary level of exposure that is potentially more worrying – through international banks lending to each other. Here the greatest risk stems from Italy and France. International bank claims on Italy total $939 billion, and French banks account for well over one-third of that, BIS data show. French banks also rely heavily on short-term loans from other international banks for their daily operations. If Italian debt slumps even further, causing deeper losses for French banks, international banks could stop lending to France. The losses would ripple through the whole global financial system.

The United States learned the hard way how these indirect financial linkages work when imploding credit default swaps forced it into a $180 billion bailout of insurance giant American International Group in 2008 to prevent further contagion in the banking sector.

The danger is that a steep drop in sovereign bond prices prompts similar margin calls at banks

So it is probably not as bad as $4 trillion. How comforting.