Thursday, August 4, 2011

Banking Worries In Italy and Spain on the Rise

link here to article

The fall in the market value of sovereign bonds in Italy and Spain is the latest problem that is causing concern in Europe. The large banks in these countries have been major lenders to their governments. When the bonds fall in value on the market, two bad things happen to the banks. The bonds are held as assets on the bank's books. When they fall in value the amount of capital backing bank assets falls below acceptable standards. The other problem is that banks borrow from other banks, and from wholesale lenders like money market funds, to meet liquidity needs. They use the government bonds as collateral to make those loans. As those bonds fall in market value it becomes more expensive for the banks to satisfy their liquidity needs. That was the problem that caused the failure of Lehman and Bear Stearns in the US during the financial crisis. They were borrowing from other banks, and from money market funds, to meet liquidity needs and they were using AAA rated mortgage backed securities as collateral. When those assets fell in value they became less acceptable to wholesale lenders as collateral.

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