These last couple of days have very much been a reality check for shareholders of Australia's big four banks. Around $9 billion was wiped off the banking index by the close of trade on Monday. Two of the big four banks were down as much as 3 per cent. Despite relatively low volumes, it was clear the banks were out of favour.
A series of events sparked the sell-off. Two major events included the downgrading of Greek debt and plans by Greek authorities to sell-off some key infrastructure to help payoff debt, as well as weaker manufacturing data coming out of China. Both are potential early warning signs of a bigger drama to unfold later. That is, a credit crunch in Europe impacting Chinese growth and eventually hitting Australia's GDP.
On Monday, however, the focus was on Australian banks. The concern is that their exposure to Europe and their reliance on offshore wholesale debt markets in the euro zone is too great. Yes banks do borrow from the Reserve Bank but the majority of their funds come from abroad. The problem is that as debt out of Europe becomes more expensive (rates rise as risk aversion accelerates), our banks will no doubt try to pass that on to business borrowers and mortgage holders. Not only could that potentially hurt demand for loans but, if they can't pass it on, it will ultimately hit their margins...and their earnings.
Investors hate uncertainty and at this point, despite the on-going nature of the debt drama, much of ultimate outcome is still being worked out. That's why investors have decided to cut and run.
There are those however that say this is being overplayed. I spoke with BT Financial Group chief economist Chris Caton earlier this week and he was of the view that our banks weren't as exposed as what the share market's suggesting.
There is the real concern though - down the track - that a full-blown debt crisis in Europe will hurt Chinese growth (by cutting into exports to Europe etc.) and that in turn could cause real damage to the Australian resources sector. This is not however a short term concern.
A prudent investor will be watching these developments closely.