European Bank Leverage

The graph above shows the leverage of private banks in various developed countries.  The data come from the IMF Global Financial Stability Report of April 2011, Table 1.1. "Leverage is defined as tangible assets to tangible common equity for domestic banks."

Here's a simplified picture. A bank has assets such as loans it has made to households, businesses, and other banks. The bank also has liabilities, such as checking and savings accounts of individuals and other institutions (your checking account is a liability to your bank, because if you show up to withdraw your money, the bank has to give it to you). If you add up all the assets, and all the liabilities, the assets should be bigger than the liabilities (or the bank is insolvent). Now the difference between the assets and the liabilities is the equity of the bank (notionally, the money that should be left over if the bank sold off all its assets and used them to pay off all its liabillities).  Then the leverage is the ratio of the assets to the equity.  So high leverage means that assets only just barely exceed liabilities.  Here's a picture to illustrate the difference between leverage 13 (the position of US banks) and 32 (the position of German banks):

Running at high leverage means living dangerously.  If something starts to go wrong with the bank's assets (let's say there's a recession, and some of the companies and households that owe them money default), then they only need to have their assets impaired by a few percent before the bank is insolvent.

So anyway, the upshot is that euro area banks have been living very dangerously.  German, French, and Belgian banks all have much higher leverage than US banks (which presumably learnt their lesson in 2008).

Recently, we've seen the European Central Bank taking an extremely hard line with Greece and other PIIGS countries:

FRANKFURT (MNI) - The solution to the problems facing Greece should under no circumstances include any credit event or default, European Central Bank President Jean-Claude Trichet said in an interview released Thursday, reiterating the concern he has expressed repeatedly in recent weeks.

Trichet told The Times of London that it is "not advisable" for authorities "to embark on a compulsory way of dealing with" the Greek issue.

"We are telling them that doing anything that would create a credit event or selective default or default is not advisable," he emphasized.

While making it clear that the decision rests with national governments of the Eurozone, Trichet also observed pointedly that once the decision has been made, the ECB "will take all the appropriate decisions ourselves as far as the Eurosystem is concerned, in line with our statutory obligations."

"But again, we are saying very clearly that they should avoid compulsion, a credit event, or selective default or default. Our position is clear," he added, declining all further comment when asked about the possibility of a compromise.

Senior ECB officials have warned recently that the central bank would not be able to accept Greek bonds as collateral in refinancing operations were they to be considered in default. This, they have noted, could lead to a virtual collapse of the Greek banking system.

As to the idea of Greece, Ireland or Portugal withdrawing from the common currency, Trichet said it was "not a working assumption that anybody considers." He said that nobody in an official position had ever raised the possibility with him.

Presumably, the fragility of the European banking system is factoring into this hard line.  However, it's not clear that the Greek population is going to go for it:

Stone-throwing Greeks clashed with police and tens of thousands of protesters marched on parliament on Wednesday to oppose government efforts to pass new austerity measures for the debt-stricken euro zone state.

Unions representing half the five-million-strong workforce also launched a nationwide strike, shutting ports, schools and other basic services in the Mediterranean state.

Prime Minister George Papandreou must push through a new five-year campaign of tax hikes, spending cuts and sell-offs of state property to continue receiving aid from the European Union and International Monetary Fund and avoid default.

He not only faces public protests and resistance from a conservative opposition that has surpassed his Socialist party in opinion polls, but a few backbenchers in his own parliamentary grouping are also threatening to reject the plan.