Europe didn’t roll back post-2008 banking rules. That was smart
Shares in European banks slumped Wednesday as speculation about the health of Credit Suisse
(CSGKF) reignited the market turmoil sparked by the collapse of Silicon Valley Bank.
Yet Europe’s lenders are in a stronger position than many of their US peers to weather rising interest rates and the storm unleashed by the demise of SVB and another regional player, Signature Bank, analysts tell CNN.
The rout in bank stocks has been much less severe in Europe than in the United States since the wheels started to come off SVB last Wednesday.
Europe’s benchmark Stoxx Europe 600 Banks index, which tracks 42 big EU and UK banks, has fallen 13% since last Wednesday’s close. Meanwhile, the KBW Bank Index, which tracks 24 leading US banks, has plummeted nearly 23%.
On Tuesday, rating agency Moody’s downgraded its outlook for the entire US banking sector, and said it expected to see more US banks come under pressure. It did not lower its outlook for Europe.
“A critical difference between the European and US systems, which will limit the impact across the Atlantic, is that European banks’ bond holdings are lower and their deposits more stable, having grown less rapidly,” Moody’s said.
Following the 2008 financial crash, regulators on both sides of the Atlantic tightened rules for banks to ensure they were better able to cope with potential losses, and to discourage excessive risk-taking.
But the United States has rolled back some of those safeguards in recent years.
Jonas Goltermann, deputy chief markets economist at Capital Economics, said smaller US banks like SVB “are basically held to a lower standard” than banks in the European Union and the United Kingdom, or larger US lenders.
In 2018, former President Donald Trump watered down key parts of the Dodd-Frank Act, which set stricter rules for the banking sector. Small and mid-sized banks — those with assets below $250 billion, like SVB — were exempted from some of the rigorous capital requirements applied to larger institutions, and from the obligation to undergo tests of their ability to withstand financial stress by the Federal Reserve each year.
Previously, only banks with assets below $50 billion had such loose oversight.
That meant SVB was able to snap up government bonds when interest rates were low without facing questions from regulators as to how it would manage if interest rates rose sharply and the value of those assets fell.
It didn’t manage. As the Fed hiked rates at an unprecedented clip over the past year to tame inflation, SVB’s customers — most of them cash-strapped tech companies — rushed to pull their money from the bank.
To pay depositors, SVB needed cash quickly, and so it sold part of its bond portfolio at a loss. That triggered a chain of events that eventually caused its downfall.
“Stress tests would have discovered” the risks in SVB’s balance sheet, Goltermann said. Even much smaller banks in the European Union are subject to regular testing by the European Central Bank (ECB), he noted, with only those holding assets below €30 billion ($32 billion) exempt.
European banks are also less exposed to fluctuations in the bond market.
According to Moody’s, debt securities — which include government bonds — make up about 12% of banks’ balance sheets across the 20 countries sharing the euro currency, compared with 30% across all US commercial banks.
US lenders are sitting on $620 billion in unrealized losses — from assets that have decreased in price but haven’t been sold yet — as of the end of 2022, according to the Federal Deposit Insurance Corporation.
Matthew Gilman, European equity strategist at UBS Global Wealth Management, said in a Wednesday note that European banks showed “material differences” to their US counterparts, owing partly to their smaller unrealized losses, though he did not provide an estimate.
The eurozone’s main interest rate has soared from a negative 0.5% in June to 2.5% in February, and the ECB is still widely expected to hike it again when it meets Thursday, despite the market turmoil. But European banks are required to hold capital to cover the risk of a large and sudden change in borrowing costs.
“This means that European banks have less exposure to market risk on bonds, despite a similar rise in yields,” Moody’s said in its note.
European lenders also benefit from stronger cash balances parked in central banks, making it less likely that they would need to sell assets to cover losses, the ratings agency added.
A SVB-style run on deposits is also less likely in Europe, given its banking sector’s relatively limited exposure to embattled tech and crypto companies.
“The deposit base of big European banks is much more stable than that of Silicon Valley Bank and Signature Bank because it comes mainly from a large number of small retail companies and commercial depositors,” Holger Schmieding, chief economist at Berenberg bank, said in a note Tuesday.
SVB’s problems were “an outlier, even within the US system,” Goltermann of Capital Economics added, pointing to its excessive exposure to a single industry.
The Fed is now considering imposing stricter capital and liquidity requirements on mid-sized banks — those with between $100 billion and $250 billion in assets — following SVB’s demise, the Financial Times reported Tuesday, citing an unnamed source familiar with the matter.
Still, despite its tougher rules for smaller lenders, Europe is not immune to a potential run on its banks or a rout in their stocks of the kind induced by pure and simple panic.
“The worry is that banks sitting on large unrealized losses in their bond portfolios might not have sufficient buffers if there is a fast withdrawal of deposits,” Susannah Streeter, head of money and markets at investing platform Hargreaves Lansdown, said in note Wednesday.
“Although the biggest players are judged not to be at risk…,” she wrote, “the nervousness is palpable.”