Much of the recent comment about Europe's sovereign debt crisis has focused on Greece’s debt mountain, the need for a second bailout or the likelihood of a Greek default - controlled or otherwise; but just as pressing is whether the Greek crisis could ripple out to engulf one of Europe's biggest economies and wreak havoc on the monetary union.
If Italy were to be dragged into the crisis, it would be disastrous for the European banking system. The European Banking Authority (EBA) stress tests revealed that some of Europe's biggest banks are far more exposed to Italian sovereign debt than to Greek.
And if there is concern about Greek banks holding Greek sovereign debt to the tune of 27% of Greek gross domestic product (GDP), how much more worried should eurozone leaders be that Italian banks hold domestic sovereign debt equivalent to 32% of the country's GDP? The chart below clearly shows how Italian banks' debt holdings are dominated by Italian government bonds.
Italy came under pressure in mid-July as the government tried to pass austerity measures in a bid to calm the market. The country’s government debt is forecast to be 120% of its GDP this year. The cost of financing may rise by €3.2bn in 2011 according to economists.
