That’s a very good question. If you have faith in the EBA tests, then you will know that out of 90 EU banks, a total of 24 either failed the tests, or are in the danger zone. That is 26% and not very good, especially if there is trouble ahead. Moreover apparently while the tests indicate a bank’s ability to cope with various adverse business and market scenarios, default by a sovereign country, or several of them, is not taken into account.
This is very much like the unsinkable Titanic. It was indeed unsinkable if it hit an object head on and if inrushing water did not fill more than the first (I think) four watertight compartments. The accident which occurred was not quite to this specification. The blow was not head on but glancing and the breached compartments were five not four. Down it went to the bottom. There were not enough lifeboats because it was assumed that as it could not sink, they would only be needed to shuttle passengers from a crippled ship to other vessels standing to. Because all these assumptions proved flawed the most famous maritime disaster in history happened.
If a country defaults in chaos while politicians argue, other countries will be forced to follow, if not by the markets, by their voters. The losses will at once bust the banks who have lent directly to these countries, those who have leant to those banks and those banks which have done neither but have insured those who have. That is most, if not all, of them.
After the Titanic sank, its identical sister, Olympic, was taken out of service and modifications were carried out to overcome the flaws and make it unsinkable no matter what. It sailed on, much loved, until at length reaching honourable retirement. The banks must now be sufficiently capitalised, their activities sufficiently ring fenced and their business models organised according to banking, not gambling, principles, if they are to face and survive what is likely yet to come.
It would be even better if politicians could get real about these mountainous sovereign debts, recognise they can never be paid in full and come up with some numbers which will allow an orderly, collective default under the general spin of debt re-structuring. The actual losses can then be quantified and plans laid, as in the third world debt crisis, to absorb them.
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