Europe on brink over Greek debt

EUROPE and the world's financial system face a critical few days as Greece runs out of options to stave off economic collapse.

The euro zone's finance ministers have delayed a decision on whether to release €12 billion ($A16.2 billion) for the next Greek bailout until early next month, putting pressure back on the beleaguered Greek government to prove it can steer through reform efforts to cut crippling debt.

The first big test comes tonight when Prime Minister George Papandreou faces a confidence vote over his efforts to slash spending and push ahead with financial reforms. Failure to back the austerity package and a large-scale privatisation program would offer little incentive for Europe to approve the next instalment from its mammoth €10 billion rescue plan. Greece needs to secure the funds by the middle of next month to remain solvent.

Even if Europe backs the release of the funds, that would be unlikely to provide much resolution to the country's long-term debt problems.

At its worst, a default - failure by Greece to redeem or pay interest on its bonds - would cause savage losses for European banks and some fear could cause a global financial panic similar to the events of September 2008 when Wall Street bank Lehman Brothers collapsed. Global money markets froze up, with investors pulling money out of bank bonds and other corporate debt and piling into only the safest government bonds.

''The lesson from the global financial crisis is that the global financial system is much more interconnected than in the past,'' says Macquarie Securities banking analyst Craig Turton.

While Australia is not in the direct firing line, with local banks having a relatively paltry $2 million exposure, it may be buffeted by shock waves, as it was during the last global crisis.

Already, funding costs for Australian banks have increased by 15 basis points over the past few weeks as problems intensified. This could gradually squeeze bank interest margins, ultimately affecting earnings.

A default would force the holders of Greek bonds - mostly banks - to write down the value of their holdings. European banks hold €39 billion worth, with the French, German and Belgium banking systems most exposed.

A second-order impact would include a slowdown in lending between banks.

Reports have already emerged that some British banks have been pulling funds from euro-zone money markets, a sign of the onset of a new credit crunch for Europe's banks.

But the biggest worry is that a Greek collapse could trigger a crisis of confidence in other weak links, namely Portugal or Ireland and even Spain.

Given the large exposure of these countries' banking systems to one another, this is where the risk of contagion is highest.

A default would hit Greece's banks hardest as they are the biggest holders of Greek government debt. With some 12 per cent of the country's banking assets made up of Greek government-backed bonds, most banks there would become insolvent. This would set off tremors in parts of eastern Europe and the Balkans where Greek banks have expanded aggressively in the past few decades.

Other European banks would be forced to revalue some private and business loans to Greece as its economy collapses.

The interest rate on Australian 10-year government bonds is a little over 5 per cent, fractionally above the official cash rate of 4.75 per cent. Yesterday Greek 10-year bonds were offering a yield of 17.1 per cent, substantially above official cash rates of 1.25 per cent. This is the market's way of saying Greece's time is up.

This story was found at: http://www.smh.com.au/business/europe-on-brink-over-greek-debt-20110620-1gbtb.html