UK banks exposed to struggling European economies

(Tim Ireland/PA Wire)

UK banks have a near-£100 billion exposure to the struggling European economies currently sending shockwaves through global markets.

Nerves are frayed because a sovereign debt default by Greece - and even Portugal and Spain - could rip another major hole in bank balance sheets shaken by the financial crisis.

According to the Basel-based Bank for International Settlements (BIS), UK banks had a total £76.2 billion exposure to the Spanish economy in corporate and government lending at the end of September last year.

They also lent £7.8 billion to Greece and £15.6 billion to Portugal, according to the BIS figures.

The fears have weighed on bank stocks, with Barclays shares down almost 20 per cent in the past month. Royal Bank of Scotland and HSBC have shed 16 per cent and 13 per cent respectively.

The spiralling deficits racked up by the southern European countries in the recession are now requiring firm action, but pushing through with the drastic plans could provoke industrial action and social unrest.

According to figures from Barclays Capital, Greece's deficit stands at a mammoth 14.1 per cent of national output, with Portugal and Spain at 9.4 per cent and 10 per cent respectively.

This week the Greek Government pledged to cut its soaring deficit to less than 3 per cent in 2012 - under pressure from the European Union - through tax hikes and 10 per cent cuts in public sector wages.

This has already provoked strikes, and two of the three major ratings agencies currently rate the country's debt at little more than junk.

The woes are also putting intense pressure on the single currency, sending it to an eight-month low against the dollar as investors seek the relative safety of the greenback.

James Hughes, a market analyst at CMC Markets, said: "The Greece sovereign debt story is starting to dominate markets as fears start to grow of the country defaulting on debt payments, being bailed out by the IMF and even the possibility of being thrown out of the euro.

"This story also has the added equation of Portugal, Spain and even Ireland going the same way. The feeling is that if Greece goes then others will follow in the domino effect."

Ratings agency Moody's has taken a damning view on the prospects for Portugal, where a bond sale by the Government flopped earlier in the week.

"Given its historical performance on fiscal adjustment, Portugal faces a kind of 'slow death', where growth remains sluggish, thereby stalling incomes, and debt continues to build over time.

Spain's economy has taken "a very severe hit" but has not been permanently damaged by the crisis, making it more resistant to a ratings downgrade, Moody's added.

But what lies ahead for the UK, where borrowing is expected to reach a record £178 billion in the current financial year?

Despite the doom-laden predictions of the world's biggest bond fund, Pimco, which last month warned UK bonds were "resting on a bed of nitroglycerine", Barclays Capital economist Simon Hayes believes there is little risk of a sovereign default.

He said: "The UK had a better starting position because we had a lower level of debt to begin with although the pace of deterioration has been alarming.

"The issue for the UK is more about halting the pace of decline, that things are not going to keep getting worse at the same sort of rate."

Tackling this will be down to the next Government after a looming general election at which the economy and spending cuts are likely to take centre stage.

"People know that the squeeze is coming," Mr Hayes warned.