Grexit to have ‘modest’ cross-border impact

A hypothetical Greek exit would have only a ‘modest’ cross-border impact on neighbouring eurozone countries, according to a new report by ratings agency Fitch.

The report suggests that despite Greek and Cypriot banks being severely exposed, the direct impact of Greece leaving the eurozone would be limited on most of the other eurozone banks, with only those banks with subsidiaries or branches in Greece most affected. The report also highlights that the impact these banks face would depend on the extent to which they are funding Greek assets cross-border.

However, Fitch said that the indirect impact of any Greek redenomination is likely to hit eurozone countries severely, especially Spain and Italy, and it expects a robust response from policymakers to prevent contagion, with a strong public statement by the ECB and eurozone politicians to provide support. Fitch also point to any statements made by policy makers needing to be backed up by specific policy actions.

After Greek banks, Cypriot banks are most exposed to Greek redenomination risks given their direct exposure to Greek loans and to the Greek economy through their large branch networks in the country.

Fitch believes the impact on banks’ Issuer Default Ratings (IDRs) in the rest of the eurozone would depend on the effectiveness of the policy response. Banks in Portugal and Ireland are more vulnerable to contagion risks as these nations could be perceived “next in line” for a euro exit.

According to Fitch, if the EU policy response fails to control contagion risks and if bank runs and capital flight were to become a reality, banks in these countries would be under severe stress. The €100bn credit line extended to Spain to support its banks should help to reduce some of the contagion there.

Recently, Gary Baker, head of European equity strategy at BofA Merrill Lynch Global Research, spoke of the need for decisive actions required by eurozone policy makers: “It’s not just a case of any old policy will do, what the market is now demanding is a lot more seriousness in detail and, if you will, a pan-European if not a global response to this rather than peace-meal efforts.”

Fitch claims that the willingness to extend a €100bn credit line to Spain to support its banks is a clear sign of policymakers’ willingness to do what is necessary. While a Greek exit is not Fitch’s base case scenario, a second Greek election on 17 June and the increasing possibility that a populist, anti-austerity party will come to power has heightened risks for some banks.

Fitch’s (IDRs) on the five Greek banks it rates are now all at ‘CCC’. The banks’ Viability Ratings (VRs), which strip out extraordinary support potential, are all at ‘f’. Redenomination of the currency and conversion of deposit and other liabilities would be considered to be a distressed debt exchange (DDE) for Greek banks under Fitch’s criteria, given that this would be a markedly devalued currency.

Redenomination would also result in escalating impaired loans for these institutions, while deposit runs prior to enforced freezes and loss of ECB liquidity would hit funding.

Banks in the stronger eurozone countries under the most rating pressure from a Greek exit would be those with the weakest funding profiles and the highest direct exposure to peripheral countries.

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