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I have been looking at investing in bank stocks in a country that may default. The prices seem very low right now, even considering the risks. What truly happens to bank stocks in a country that defaults on its debts? Do the stocks become worthless, almost like a company emerging from bankruptcy where the common stocks are wiped out and the company issues new shares? It seems as though almost a complete shutdown is priced in currently.

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2 Answers 2

The prices seem very low even considering the risk? The prices are low because of the risk.

Nothing happens to the banks if the sovereign defaults. However, the sovereign debt holders - lose some or all the money they lent to that sovereign. Incidentally, many banks invest in the treasury bonds of various countries, especially those they're located in. They also invest in other companies that rely on the government, or the currency. If that dependency is too high - the bank may fail. If the dependency is not high, or non-existent - the bank will survive. If the bank fails - yes, your shares will be wiped out, that's what happens with bankrupt companies.

If you considering investing in banks in a country that you think may default - research them and see how much investments they have that will be affected by that default.

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As a specific example, I read today in that Greek banks have somewhere between 22-50% of their assets in Greek government debt (depending who and which accounting method you believe), and this is over twice their equity. (Not quite the right cite.) So if the government defaults on, or restructures, its debt, which some writers consider nearly inevitable, the banks will be in a parlous situation and their shareholders will be wiped out. –  poolie Sep 28 '11 at 0:35
    
@poolie - Govnerment debt is never wiped away like personal debt can be. They will owe that money until it is repaid. Restructing could be a good thing as it should improve the viability of the debt... assuming they can figure out a method to pay the debt down. If it was a business they could downsize... –  user4127 Sep 29 '11 at 17:01
    
@Chad: While there is no formal bankruptcy mechanism as there is for persons or companies, governments can default and can negotiate with their creditors to pay back less money: that's what debt restructuring means. In the case of Argentina in 2002 exchanging many bonds for others at a lower value or longer duration. In Greece in 2011 bondholders have already agreed to write down some of the debt; for the bondholders that's now an unrecoverable loss; it is gone. –  poolie Sep 29 '11 at 23:32
    
@poolie - Generally with restructuring you set up the debt with lower payments over longer term reducing your monthly output but generally paying more in total interest. But yes sometimes they can reduce the interest rate so it would be lower but that is still a win for both sides and could be good if Greece can right its ship. If it doesnt then Illinois can watch Greece to see its future. As for the written down debt. If Greece gets back on its feet that debt will pop back up. It may be 25 years but someone will want paid. Its happened all over Africa –  user4127 Sep 30 '11 at 12:47
    
@Chad to come back to this particular case: a bank with 50% of its assets in supposed-to-be-safe bonds that are likely not going to be fully paid on time, if at all, is not a healthy bank. I don't think other parties are going to be reassured by an argument that they have a slim chance of eventually getting the money back after a decades-long lawsuit. –  poolie Oct 1 '11 at 5:07

Most national banks are required by the regulations of their host countries to hold significant reserves in the form of government debt. A default would likely wipe out their capital and your common stock would become worthless. The common stock only has positive value today because of the option value based on the possibility the host country will evade a default.

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