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How Greece's EUR Exit Could Lead To Massive European Banks Failures

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Greece calling for a fresh round of parliamentary elections on Tuesday marked another act in the country's EUR exit scenario. If recent polls are indication of the possible make-up of the new government, it's likely that the radical left will form this upcoming government. Once in power, the new Leftist government will likely declare debt moratorium, and in return the EU/IMF funding program will be suspended.

That will lead to a sequence of disorderly events ending with Greece leaving the EMU and reintroducing its old legal tender "the Drachma." This is when the black market dynamics would come into the picture: As all the deposits in the Greek banks will be re-denominated in the Drachma, the official Central Bank's exchange rate will be completely different from the defacto exchange rate in the black market. Greek depositors in turn will incur significant losses; the prospect of this scenario has already caused Greek depositors to withdraw EUR 700 millions since May 6 according to a Bloomberg report.

In that environment, two main repercussions on European banks will take place: First, the cost of funding will be raised substantially across most of the European banks. Here, we might expect another coordinated Central Banks intervention to provide liquidity into the financial system. But even with that, European bank would still operate under immense pressure.

Second: seeking to avoid the same fate of the Greek depositors, other European depositors in countries that are excepted to follow Greece like Spain and Portugal will start a series of runs on their local banks. Given the history of slow reactions by the European institutions, a deposit flight in Southern Europe might be left to have the magnitude to spread to some troubled banks in Northern Europe. At this juncture, it might only take the collapse of one prominent bank that depositors label as immune to lead to massive failures of European banks.

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