The author is Managing Director at Frontline Analysts and author of Lying for Money
As the old T-shirt slogan used to say, if you see a bomb disposal expert running down the street, don’t ask them what happened, just try to keep up. In a financial crisis, there is a tendency for investors to act similarly, fleeing when alarm bells ring.
In such feverish times, bank regulation can overwhelm experts throwing bombs and talking loudly about the market. This is not always wrong.
Although sometimes ridiculous, the alarmist’s job is to push against a major failing of experts and experts—the tendency to remain in denial, focus on technical issues, and miss the big picture. If the four most dangerous words in finance are “it’s different this time”, the five most expensive words may be “it’s more complicated than that”.
With all these caveats, there are many reasons to believe that the European banking system is not as vulnerable to the current storm as US regional ones of comparable size. This is not because European banks are very good – it is precisely because they have historically been very bad.
Over the past week, analysts have made plenty of good points about the differing structures of the two banking systems. For example, regulatory filings by BNP Paribas published on Tuesday show that its profit and loss account has little sensitivity to interest rate movements. BBVA, to take another name at random, has hardly any sensitivity to interest rates on its shareholders’ funds – less than a 2 percent difference in the economic value of its equity for every 1 percentage point move.
European Regulators has published a detailed set of standards for testing interest rate risk with the expectation that they will be applied to every significant bank in Europe. Unrealized losses are not ignored. Global Basel standards on stable funds are implemented across the sector.
However, practically every banking regulation commemorates a time when things went horribly wrong. Europe has spent a decade tightening regulation as it weathered a multi-year euro crisis. The current generation of chief executives in Europe knows that when things go pear-shaped, they are not given the benefit of the doubt. The same generation in North America has had more than a decade of complacency since the 2007-8 financial crisis.
So, why is there so much contagion in equity prices? Partly because crises are always less of a test of the banking system and more of a test of the bailout system.
We can see some evidence of this from the fact that the main location of the contagion is Credit Suisse where I once worked as an analyst. Credit Suisse is in contrast to the almost completely collapsed Silicon Valley bank. But it is based in Switzerland, where the relative size of the economy and banking system have in the past raised questions about its willingness to support anything other than core Swiss operations.
This leaves Credit Suisse vulnerable to the one thing it has with SVB and its signature (another US bank has closed in the past week) – potentially unfrightened depositors. However, the SNB has now announced backstop liquidity support for the entire “globally active” business.
Although the European Union has gotten unprecedentedly better at organizing central bank funding through programs such as targeted long-term refinancing operations, it still lags behind the US in understanding that it may be cheaper to bend the rule sooner rather than later. can A strict “no bailouts” position and then reversing it when things get really bad.
It is a shame that there is no shared deposit insurance system in the Eurozone, and state aid rules are a serious obstacle to the flexibility that the Federal Deposit Insurance Corporation in the US has so far enjoyed.
Which means it all depends on whether this is a big crisis or a small one. In a minor crisis, the fact that European banks are currently better regulated and less exposed to interest rate risks should protect them. In a real crisis, however, the faultlines of the European financial system will reappear, unexpectedly. The arc of financial history tends to arrange itself to maximize embarrassment.
