Europe Strains World's Banks

The world's financial system showed new signs of strain on Wednesday as banks and investors clamored for U.S. dollars and two European banks took emergency measures to address the deepening crisis.

Stresses rippled through debt and stock markets despite measures taken by European leaders last week to help restore investor confidence. Reflecting the tension, rates that banks charge each other for short-term borrowing in dollars continued to climb, hitting their highest level since July 2009. Long-term Italian government bond yields jumped back above 7%, a level that would crimp Italy's ability to borrow in the future. Amid the rush for dollars, the euro dropped below $1.30 for the first time since January.

Crédit Agricole SA, France's third-largest bank, said it will exit 21 of the 53 countries in which it operates to help shore up its finances. Commerzbank AG, struggling to avoid accepting a bailout by the German government, is in negotiations to transfer suspect assets to a government-owned "bad bank."

The Dow Jones Industrial Average dropped 1.1% to 11823.48. Markets in Japan, Australia and South Korea each fell more than 1% in Thursday morning trading.

Investors fret that the recent steps taken by Europe's leadership have done little to dissipate the growing strains across the markets. The concern is that with no solution in sight to the sovereign debt crisis, banks, which hold hundreds of billions of dollars of European government bonds, are at risk of suffering massive losses, threatening to cripple the Continent's banking system.

In this environment both investors and banks are demanding higher interest rates in return for the risk. Some are just refusing to lend. The retreat threatens to create a vicious cycle for the euro zone and could worsen the impact on the region's already weak economy. Europe is far more dependent on lending from its banks than the U.S. economy, where financial markets play a greater role financing companies and individuals.

"The problems are very large and the solutions are very difficult," said Gerard Cassidy, a bank analyst at RBC Capital Markets.

European banks are exposed to big potential losses in countries like Italy and Spain. The banks have huge portfolios of government bonds, and an increasingly likely European recession would hurt the value of all their assets.

In the U.S., the government stepped in to prop up ailing banks during the 2008 financial crisis. Only after the banks were stable did they ask private investors for more capital to shore up their balance sheets. In Europe, the approach has been the reverse, in part because many European governments have piled up debt without having yet bailed out their banks.

Fitch Ratings on Wednesday evening lowered its ratings on five big banks from Denmark, Finland, France and the Netherlands. Fitch said the downgrades reflected deteriorating market conditions.

Earlier in the day, focus was on the potential downgrades of sovereign nations, as France's finance minister played down the potential impact of any downgrade of France's Triple-A rating.

As the European financial crisis developed, concerns about the euro-zone banking system have mounted.

read more: Olympus Wealth Management