Suzanne Staton' blog: France Keeps a Watchful Eye on Italy?s Troubled Finances

By NELSON D. SCHWARTZ and LIZ ALDERMAN

Published: November 13, 2011

First it was Athens. Then Rome. Could Paris be next?

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While Italy has replaced Greece as the focus of anxiety amid Europe?s worsening debt crisis, investors are increasingly concerned about the outlook for France, whose banks are among the world?s biggest and are closely linked with their counterparts in the United States.

One crucial gauge of investor sentiment, the difference between what France pays to borrow versus what Germany pays, has doubled since the beginning of October, and last week reached its widest point since the formation of the euro currency zone in 1999. Meanwhile, speculation that France could soon lose the sterling triple-A rating on its sovereign debt intensified after Standard & Poor?s mistakenly told clients on Thursday that it was downgrading France?s debt.

The jump in Italian bond yields to more than 7 percent last week, on concern about Rome?s ability to borrow, reminded investors just how much Italian debt French banks hold.

But French banks also hold a lot of French government bonds, whose yields have risen in tandem with concerns that Paris?s finances may be strained as it foots a larger bill to help prevent the crisis from engulfing Italy.

?Once you are dealing with Italy, you are dealing with France as well,? said Hans Mikkelsen, senior credit strategist at Bank of America Merrill Lynch. ?This is cutting into the core.?

French banks are also more dependent on short-term financing than their rivals elsewhere, leaving them vulnerable if Italy?s problems create a Lehman-like freeze in credit markets.

For the moment, the ascent of a new interim government in Rome and the appointment of Mario Monti, a former European commissioner, as prime minister, have calmed those fears. French politicians, regulators and bankers insist that Italy?s problems are contained, and will not affect French banks, which have slashed their holdings of Italian sovereign debt in the last few months.

But French banks, and others on the Continent, have traditionally turned to American money-market funds to finance the gap between what they possess in deposits and what they owe, and though French banks have cut this borrowing substantially in recent months, it is still huge. At the end of October, money-market funds in the United States owned $84 billion worth of French debt.

Estimates for total American bank exposure to France vary widely. Direct holdings of French sovereign debt are small but total exposure runs into the hundreds of billions, according to the Bank for International Settlements. A recent Congressional Research Service report estimated that American bank exposure to German and French banks totaled more than $1.2 trillion

The roots of France?s exposure to Italy lie in the decision by French banks to expand aggressively over the last decade by acquiring banks there and operating big branch networks. BNP Paribas, which bought Banca Nazionale del Lavoro of Italy five years ago, holds 12.2 billion euros in Italian sovereign debt, despite reducing its Italian bond holdings by 40 percent since the summer and whittling its exposure to Italy to 1 percent of its total commitments.

?We are in a much better position to face any problems than we were three to four months ago,? said Antoine Sire, the head of communications at BNP Paribas in Paris. A recent stress test by the European Banking Authority showed that BNP did not need to raise more to guard against a worsening of the crisis.

Cr�dit Agricole, another French financial giant, holds 8.7 billion euros worth of Italian bonds. Soci�t� G�n�rale, whose shares have been pounded in recent months on fears of a Greek default, holds 1.5 billion euros in Italian bonds after it also slashed its holdings.

Indeed, among banks on the Continent, French institutions have been the most exposed to Italy, according to a recent report by Keefe, Bruyette & Woods, holding more than $100 billion worth of sovereign Italian bonds and on the line for an additional $300 billion in loans to private borrowers like Italian companies and consumers, though these figures have been dropping in recent weeks.

As a result, imposing a write-down in the value of Italy?s debt, a so-called haircut, would have a much more devastating effect on bank capital levels than the 50 percent reduction in the face value of Greek debt agreed to by European leaders last month.

What is more, the amount of money owed by Italy ? just under 2 trillion euros ? dwarfs the 350 billion euro debt load of Greece.