14 April 2013

Reuters: Eurozone bank troublespots don't come down to size

Although the implosion of Cyprus's bloated banking system has put other eurozone economies with outsized financial sectors such as Luxembourg and Malta in the spotlight, loan quality is the real litmus test of a country's financial stability.

What caused the Cypriot problem was that Cyprus's two main banks used the gush of deposits to gamble on the Greek economy, leaving them horribly exposed when Europe imposed losses on Greek sovereign bonds. The implosion of the Greek economy rotted their loans to that country.

Officials from Luxembourg, anxious to protect the country's reputation as a hub for international capital, are quick to draw the distinction between their risk exposure and Cyprus's. Though it has the largest banking sector in the eurozone, at an eye-watering 22 times GDP, and a population of only just over half a million people, roughly equivalent to Tucson, Arizona, the Grand Duchy is keen to emphasise that its banks are healthy and its liabilities much smaller than they appear on paper.

After Luxembourg, Malta has proportionately the next largest financial sector in the eurozone, at around eight times the country's GDP. Stripping out international banks including some Turkish lenders that book a lot of their loans through Malta for tax reasons and do not take domestic deposits or lend domestically, the local banking sector has assets equivalent to under 300 per cent of GDP and is dominated by two lenders - Bank of Valletta and HSBC Malta. Malta's domestic banks had non-performing loans equivalent to 8.2 per cent of the loan book as of June 2012, according to the IMF. While the domestic banks in Malta have limited foreign exposure and have so far sidestepped any fallout from the eurozone crisis, the central bank this week called for them to raise their provisioning to better cushion them from potential losses. The vulnerability for Malta is the uncertainty caused by the Cypriot bailout, which for the first time forced large depositors and holders of senior bank debt to take losses.

Markets are betting that Slovenia, a country of 2 million perched on Italy's northeast border, will be the next eurozone country to succumb to a bailout. In contrast to Cyprus, Slovenia's banking system is not large - around 1.4 times as big as the economy - and there are negligible foreign depositors. But the Slovenian banks, most of them state-owned, are crippled with bad loans, which reached 14.4 per cent of their loan books last year.

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© Reuters