A few weeks ago, a piece on the FT mentioned that the Irish gross external debt was close to 1000% of GDP (not a typo!). Based on this observation, the FT commentator explained that the EFSF could provide liquidity to Irish banks but certainly not make them solvent. His conclusion might be true, but I believe that inferring solvency from gross (or even net) external debt is not correct. Today most developed countries have very large gross external positions (external gross liabilities and assets of 300% of GDP are quite common). These positions are the outcome of the massive increase in the size of capital inflows and outflows across countries experienced in the last 20 years or so. Most available data on bilateral external positions are based on the concept of residence. This accounting principle implies that a debt by, say a German bank located in Dublin on a French. resident is an external debt of Ireland vis-à-vis France, instead of a German debt. The BIS constructs a different measure (only for banks and for 24 developed countries), called “ultimate risk” basis, that identifies exposures on the basis of the nationality of the ultimate creditor and debtor. In short the “ultimate risk” basis is constructed to identify the bank that is ultimately responsible for the liability and is a better measure to assess solvency and liquidity. According to this measure, at the end of June 2010, European banks had 423 billion dollars claims on Irish banks, while Irish banks had 375.8 billion claims on European banks. Within Europe the net debt of Irish banks was therefore 47 billion or approximately 20% of GDP. The overall net figure is not available but we know that Ireland bank claims vis-a-vis “all countries” amount to 548 billion dollars and the 24 countries claims vis-a-vis Ireland amount to 518 billion. The graph below shows the creditors of Ireland (millions of dollars, June 2010, BIS.) The creditors breakup is useful to assess the transmission channels of a default and the incentives of each nation to bail out their debtor. (click to enlarge)
Portuguese banks have 80 billion dollars claims against other European banks while European claims against Portugal amount to 205 billion. Within Europe Portuguese banks have a net debt of 125 billion or 54% of GDP. Portugal bank claims vis-a-vis “all countries” amount to 140 billion dollars and the 24 countries claims vis-a-vis Portugal amount to 212 billion dollars.