Moody’s Investors Service says that the lack of a coherent monetary and banking policy framework coupled with paralysis in the local financial markets are jeopardizing the credit health and future of the Argentine banking system.

In a Special Comment released today, Moody’s assesses the potential impact on the Argentine banks of the recent devaluation and imposition of deposit and foreign exchange controls. It says that Argentine banks are insolvent even under a benign scenario in part as a result of the asset-liability mismatch created by the devaluation of banking assets, unaccompanied by the redenomination of dollar liabilities.

“The devaluation of the Argentine peso has also reduced the repayment ability of debtors in foreign currency, ” the agency notes, “and presents the potential for extremely high credit losses for the banks, resulting from an across-the-board deterioration in asset quality. “

According to the agency, the cost to the Argentine financial system will potentially represent a multiple of the system’s present capitalization levels unless liabilities are reduced via redenomination; the system will therefore need considerable external support to recapitalize.

“Right now, ” the report concludes, “the asset side of the banks’ balance sheets is severely impaired, while the liability side remains where it was before the crisis, resulting in severe insolvency. The policy of forcing the banks to repay peso and dollar deposits with dollars is unenforceable, since the banks don’t have the money, and neither does the government. “

“Therefore, the government’s simplest option would seem to be to 1) declare the banks insolvent, 2) nationalize them, 3) convert deposits into devalued pesos or into government bonds, 4) recapitalize the banks with peso bonds, and 5) auction them off.”