French Banks Squarely at Risk in Euro Debt Crisis

The big story out of Europe today is not about Greece or Portugal or Italy or any of the PIIGS states. It’s about French banks. To be sure, Greece remains on the brink of default, and European leaders are desperate to manage that. But understand that financing the Greek bailout has everything to do with using Greece as a pass-through to big banks. And no banks are more exposed to Greek debt than French ones.

Therefore, with speculation high on a Greek default, suddenly French banks are seen as not worth the risk. This is leading to a liquidity crisis at banks like BNP Paribas:

“We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore,” a bank executive for BNP Paribas, who declines to be named, told me last week. “Since we don’t have access to dollars anymore, we’re creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell.”

Keep in mind that BNP Paribas was NOT on the list of French banks downgraded by Moody’s today. The credit rating agency went after Credit Agricole and Société Générale. They are “reviewing” BNPP.

Moody’s was quick to say that French banks had the capital to absorb debt losses. But that’s only if this is confined to Greece, and the contagion to larger countries like Italy could make it unsustainable on French banks. BNPP and Société Générale are selling tens of billions in assets to ensure they have a strong buffer, but I don’t know how much you’d have to sell in the event of a breakdown. And it’s the liquidity problems that could knock out SocGen, for example.

The banks are not being wholly honest about their Greek exposure, but the markets clearly aren’t giving them the benefit of the doubt. But they hold far more Greek debt than the Brits or the Germans, and their exposure to Spanish and Italian debt is over half a trillion euros. As Felix Salmon writes:

As a result, the only way for the French banks to be able to project a credible degree of solvency is for the Eurozone to inject a huge amount of money somewhere. Either it goes into the countries the French banks have lent to, and will then be used to pay back the French banks what they’re owed, or else it just goes into the French banks directly — the TARP solution. But if the EFSF isn’t beefed up and deployed very soon, we could see some extremely big French banks either collapse or get nationalized in very short order. And nobody wants to see where the chain reaction from that would lead.

Either the Greeks will pay through austerity, or the French people will pay in a bailout event. Right now French officials appear to be in denial, saying that their banks are well-capitalized and that nationalization is out of the question. If this is mismanaged – and the potential is there – you could see a dramatic collapse that would have ripple effects globally.

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