June 24, 2011
Credit default swap insurance taken out by UK banks to hedge their exposure to sovereign debt defaults may prove worthless, financial analysts are warning.
The forecast also adds a cautionary note to claims that the UK and US financial systems have a low exposure to the debt crisis engulfing Greece, and comes as Britain's new risk watchdog, the financial policy committee (FPC), increased the pressure on banks to boost capital cushions.
Erik Britton, a former Bank of England economist and director of financial market consultancy Fathom, said: "If banks have taken out insurance with a hedge fund, are they comfortable that they will pay out in the event of a default? There is a chance that they have taken cover that is worthless. The banks could be facing a loss [on one side of their investment book] and they won't be able to claim the insurance [on the other side]. Then they may have to recapitalise."
The Britton scenario is a worst case, involving a swift default by Greece that pulls Ireland and Portugal into the crisis and then, possibly, Spain and Italy.
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