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Chart: Deutsche, Monte dei Paschi and contagion

The Bank of England has asked UK banks to outline their exposure to two stressed European banks
October 27, 2016

The Bank of England has asked the largest UK lenders to detail their exposure to troubled Deutsche Bank (de:DBK), and Italian banks including Monte dei Paschi di Siena (it:BPMS), as concerns grow around the European banking sector. The interconnectedness of the continent's largest banks creates risk for otherwise healthy lenders if a weaker link falls into trouble.

Both banks have faced scrutiny over their capital levels. As the chart below shows, the price of credit default swaps for both banks has ballooned since January, which tells us investors think the probability of these banks defaulting on their debt has increased. In June the International Monetary Fund labelled Deutsche Bank as the riskiest bank globally, with its investment and banking transaction businesses making it highly interlinked with other groups. The US Department of Justice has also demanded $14bn (£11.4bn) to settle its investigation into alleged mis-selling of mortgage-backed securties in the run-up to the financial crisis.

But there is good news for the German bank, after it reported a net profit of €278m for the third quarter, compared with a €6bn loss the previous year. This defied analyst expectations it would make a loss.

Yet Monte Dei Paschi is considered the most stressed bank in Europe. Earlier this month the Siena-based lender announced plans to cut 2,500 jobs, reduce staff costs close a quarter of its branches as part of its turnaround plan. The bank also plans to raise €5bn of extra capital.