Banking Systems - Still All For One, I'm Afraid

Whatever 2012 may bring, no-one can claim that disasters in the Eurozone and its banking system could strike like lightening out of a clear blue sky. We have all had plenty of time to get habituated to the idea that somehow, somewhere Princip will stumble upon his Archduke. Consequently, major financial centres and their regulators, not to mention Europe's banks and their ex-Euro counterparties have had plenty of time to prepare for disaster. I have tracked how this has materially altered balance sheets of foreign banks in London and New York.

The hope therefore is that given such a lengthy warning period, if and when the Eurozone's financial system really begins to implode, other parts of the world's financial systems will prove to be more robustly insulated from the damage than they were when Lehman went down. But are they?

Every day I dutifully track the CDS market for 5yr bank bonds in the Eurozone, the US and Asia, as a reasonable proxy for perceptions of systemic risk in these financial systems. If US and Asian financial systems have been busy insulating themselves from Eurogeddon successfully, then the linkage between rising risks in the Euro banking system, and rising risks in these other banking systems should be diminishing.

We can measure whether this is true by looking at how the correlations between movements in Eurozone banking system CDS rates and those in the US and Asia have developed over the year. Here's the chart, showing the development of 30-day correlation coefficients between daily movements in the underlying CDSs.

Man, I'd have loved this chart to be different. However, like it or not, we end the year with no sign that the market believes that either US or Asian banking systems have made any significant progress in insulating themselves from Euro-risk. In fact, the correlations are at or near their all-time highs.

Sorry about that.

PS. The de-coupling between Eurozone and US systems in June this year was the consequence of developments on both sides of the Atlantic. The Eurozone saw what was then the biggest and most decisive meeting to protect the Euro – at the time these meetings had more credibility than they now enjoy. On the other side of the Atlantic, we had various developments in the stand-off in how/if to continue funding the Federal government.