05 October 2011

BBC: What went wrong with Dexia

As late as 27 September, the firm's board boasted of a "robust capital base" and insisted a break-up was firmly off the agenda. But one week on, Belgian and French finance ministers plan to split off the firm's riskiest assets into a "bad bank" and remove its French local government lending operations.

Eurozone debt crisis

While problems in the US prompted the first intervention, the eurozone debt crisis is at the root of Dexia's current difficulties. The firm has €3.4 billion ($4.5bn, £2.9bn) of exposure to Greek government bonds. Analysts estimate it has a further €17.5 billion of exposure to sovereign debt issued by Italy, Spain, Portugal and other troubled eurozone economies.

In spite of all this, Dexia passed July's banking stress tests carried out by the European Banking Authority. This happened because the bank had a core tier one capital ratio of 10.3 per cent. The measure weighs up a bank's top-notch assets against its more risky holdings and is used to gauge its financial strength. Dexia's score put it well above the 6 per cent threshold demanded for a clear pass.

So on 15 July, the bank issued a press release headlined "2011 EU-wide stress test results: no need for Dexia to raise additional capital". The problem is that the tests did not take into account a scenario in which Greece might default on its bonds. Dexia has written down the value of some of its long-term Greek holdings by 21 per cent. However, some speculate that creditors may ultimately have to absorb a 50-60 per cent loss.

While the bank should have enough capital to absorb such writedowns, analysts are worried about the knock-on damage to other investments owned by the bank that would be caught up in the turmoil. "Of course, the Greek exposure is a consideration", says Pierre Lambert, a banking analyst at Keefe Bruyette & Woods. "But the key catalyst today is its freeze of access to market short-term liquidity."

"Dexia relies on short-term funds, which are renewed on a rolling basis. But the access to those funds is no longer there because of market concerns about its exposure to the euro periphery and the requirement of higher collateral."

Press release

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