London, 06 May 2010 -- As shown by the recent downgrade of Greek banks as a result of sovereign weakness, the potential contagion of sovereign risks to banking systems could spread to other countries such as Portugal, Spain, Italy as well as Ireland and the UK, says Moody's Investors Service in a new Special Comment entitled "Sovereign Contagion Risk -- Part I: Assessing the Impact on Banking Systems of Southern Europe, Ireland and the UK".
The report is available at: http://v3.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_124979
Overall, Moody's notes that each of these countries' banking systems faces different challenges of different magnitudes, but warns that contagion risk could dilute these differences and impose very real, common threats on all of them.
This Special Comment assesses the contagion risk for those systems where the transmission mechanism primarily stems from the market concerns about the sovereign credit profile, but where, prior to this pressure, the banking systems had been less affected by asset price bubbles or exposure to structured financial products. These are the banking systems of Greece, Portugal, and to some extent Italy. Despite facing a fundamentally different situation compared with Greece, Portugal is now under heightened investor scrutiny, resulting in this week's review for possible downgrade on the ratings of all Portuguese banks. A key factor determining whether contagion risk continues in this case will be the market's view of the likely success or otherwise of the recently agreed IMF and European Union support package for Greece. Italy is another country where the banking system had been relatively robust so far, but where the major risk to its banking system could also be challenged by contagion risk should the market pressures on the sovereign increase.
The Special Comment then explores those banking systems that have weakened from within, often due to excessive loan growth (mostly Spain and Ireland and to a lesser extent the UK); contagion could potentially also spread to these banking systems where sovereign creditworthiness has been impacted by developments within the banking system.
Moody's new report, the first of a two-part series, is based on a presentation that Moody's senior analysts made to investors in various European cities throughout April 2010. The second and forthcoming part of this series, which will be published shortly, will assess the exposures and capital implications for major European banking systems to the four (most) vulnerable countries.