David questions Professor Charles Goodhart of the LSE and Professor William Perraudin of Imperial College, London in Treasury Committee.

Eurozone Crisis: Impact on the UK

Orgal Evidence taken before the Treasury Committee on Wednesday 14 September 2011

Q34 Mr Ruffley: Could I ask both of you some questions about UK bank exposures? You have already indicated the limitations on estimating some of the figures. What is the order of magnitude, do you think, of potential losses to UK banks that have unhedged exposure to core countries in the Eurozone, and to non-core countries should they enter severe crisis?

Professor Perraudin: Well, I don't know.

Mr Ruffley: I know it is a relatively difficult question but, in terms of the order of magnitude, would you have any feel for the exposure of UK banks to uncovered sovereign debt holdings of both the core Eurozone countries and the periphery?

Professor Perraudin: I do not have reliable information on that.

Mr Ruffley: What would your educated estimate be? Put it another way, do you think it is potentially a problem for UK banks or unlikely to be a problem for UK banks?

Professor Goodhart : What are you describing as core? Are you including Germany as core?

Mr Ruffley: Yes. On the one hand, what is the answer to the question if we are just looking at: first, a banking crisis with the peripheral countries; and then secondly, if it is the whole of Europe, including France and Germany?

Professor Goodhart : I think if it is the whole of Europe the number of policy changes would have to be so great that the world would just look totally different. If you are talking about core Europe and widespread defaults, either at the sovereign or at the banking level, I just don't think that this is the kind of exercise that can be usefully done. You can do it, perhaps, with what would happen if there were problems in Italy. I think to-

Q35 Mr Ruffley: Let's take that then. What would be the exposure of UK banks to a sovereign debt crisis in Italy? Is the exposure such that UK banks would have a real problem or would it be an inconvenience? I am trying to get a sense of the order of magnitude. I am not asking you to give a specific numerical representation, but what would be the exposure, say, in the case of Italy?

Professor Goodhart : I am desperately trying to remember some sort of matrices on all this, which I once saw, but my memory is slipping. I am afraid this is a factual point and if you want a factual answer I think you should make a written request to those people who would know that answer, and I don't.

Professor Perraudin: I think there are BIS statistics on inter-country lending, so you could look up that.

Q36 Mr Ruffley: Yes, but I am asking you from your knowledge, and you are the experts in banking: is your sense that it might be a difficulty for UK banks, yes or no?

Professor Goodhart : I think we are most on the hook to Ireland, because the UK banks did a great deal of mortgage lending into Ireland, and I think that there are also considerable interbank links with the Irish banks, or at any rate there were. Certainly of the peripheral countries, I think that real difficulties in Ireland would be the greatest problem for us.

Q37 Mr Ruffley: What about in terms of holdings by UK banks of EU sovereign debt, whether it is the core countries or the periphery-Greece, Portugal, Ireland?

Professor Goodhart : Everybody holds a great deal of German debt and everybody holds a great deal of French debt. I don't know the figures on Italian debt.

Q38 Mr Ruffley: Could I ask about the stress tests? I think you have touched on this in your earlier answers. UK banks have been pretty much given the all clear, as have European banks, and you have indicated what the limitations are on the results of those stress tests. Could you just indicate in straightforward terms what factors you think may trigger a crisis in the periphery or in the core countries, such that would make the all clears on the stress tests a nonsense? What do you think is going to make the stress tests look a bit sicker than they are at the moment?

Professor Goodhart : Sovereign debt failure.

Q39 Mr Ruffley: Anything else?

Professor Goodhart : The extent to which that might become contagious and that, of course, would be worsened, insofar as the economies in Europe should now fall into negative output growth.

Professor Perraudin: I think our banks would only be significantly affected by failures of Spain or Italy or Ireland. I don't think that we would be substantially affected by smaller countries. So it is really a question of whether one can find ways in which to limit contagion and spreading of sovereign defaults to major countries. That is the key question for our banks.

Q40 Mr Ruffley: Where do you think the answer might lie? You talk about measures being taken.

Professor Goodhart : It would depend how the default, if there was to be one, would be handled. The great danger is that you might find that a default of, shall we say, Greece was forced, but that might lead to sufficient losses that there could be banking runs in other countries and the contagion could spread incrementally from one country to another. A contagious spread could mean one default leading to defaults of both sovereigns and banks elsewhere. The question is how a forced default of one country could be contained. I would hope that is something that the authorities in the Eurozone-because it would be primarily for them-are now thinking about very seriously.

Q41 Mr Ruffley: One final question arising from answers you have given to my other colleagues is, is there any way of making the cheating more explicit?

Professor Perraudin: Cheating by whom?

Mr Ruffley: Well, the mark to market question, the difference between the banking book and the trading book, is there anything that usefully can be done to clean all that up? You articulated it very clearly-while there may be full value in the banking book, if they are marking to market in the trading book it might look very different.

Professor Perraudin: I do not regard it as cheating. I think that having a non-mark to market approach in the banking book is not dishonest or shocking. It is simply a way of accounting for values gradually over time for things that banks intend to hold to their final maturity.

Mr Ruffley: But does it matter?

Professor Perraudin: The key thing is whether proper provisions are made against deterioration in credit quality and that really ought to be visible to supervisors. So it is a question of making sure that supervisory practices by different countries are satisfactory.

Q42 Mr Ruffley: You were implying in your earlier answers that the provisioning was maybe not as realistic as it should be, or you implied that the provisioning was questionable.

Professor Perraudin: There are certainly concerns about that.

Mr Ruffley: A final question, is there a debate going on in relation to the countries where there is questionable provisioning?

Professor Perraudin: They are seeing the problem of taking that approach right now because it is adding to concerns about their banks. This is one of the reasons why the French banks have been downgraded today.

Q43 Mr Ruffley: So it is being exposed, slowly but surely?

Professor Perraudin: Yes.

Read the full transcript here:

http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/1505/11091402.htm