The writer is a managing director at Frontline Analysts and the 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’s happened, just try to keep up. In a financial crisis, there is a tendency for investors to act similarly, fleeing when the alarm bells ring.
In such febrile times, the bomb throwers and loudmouths can drown out bank regulation specialists talking about markets. This is not always wrong.
Although sometimes ludicrous, the function of the alarmists is to push against the great failing of specialists and experts — a tendency to stay in denial, to concentrate on technical issues and miss the big picture. If the most dangerous four words in finance are “it’s different this time”, the most expensive five words might be “it’s more complicated than that”.
With all these caveats in place, there are a lot of reasons to believe that the European banking system is not as vulnerable in the current storm as are US regionals of comparable size. This is not because European banks are very good — it is precisely because they have historically been quite bad.
Over the last week, analysts have made plenty of good points about the differing structure of the two banking systems. A regulatory filing by BNP Paribas published on Tuesday, for example, shows that its profit and loss account has very little sensitivity to interest rate movements. BBVA, to take another name at random, has hardly any sensitivity of its shareholders’ funds to interest rates — less than a 2 per cent variation in the economic value of its equity for every 1 percentage point move.
The European regulators 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. Unrealised losses are not ignored. The global Basel standards on stable funding are applied across the sector.
However, practically every banking regulation commemorates a time when things went badly wrong. Europe has spent a decade toughening up regulation because it went through a rolling multiyear 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 since the 2007-8 financial crisis in which to get complacent.
So, why has there been so much contagion in equity prices? Partly because a crisis is always less a test of the banking system, and more a test of the bailout system.
We can see some evidence of this from the fact that the key locus of contagion appears to be Credit Suisse where I once worked as an analyst. Credit Suisse is almost perfectly unlike the collapsed Silicon Valley Bank. But it is located in Switzerland, where the relative size of the economy and the banking system have led to questions in the past about willingness to support anything other than the core Swiss operations.
This made Credit Suisse vulnerable to the one thing it has in common with SVB and Signature (the other US bank to be closed down over the past week) — potentially jumpy uninsured depositors. The SNB has, however, now announced a backstop liquidity support for the entire “globally active” business.
Although the EU has got immeasurably better at organising central bank funding through programmes like the Targeted Longer-Term Refinancing Operations, it is still wildly behind the US in terms of understanding that it can be much cheaper to bend a rule early on than to maintain a strict “no bailouts” position and then end up reversing it when things have got really bad.
It remains a disgrace that there is no shared deposit insurance system in the eurozone, and state aid rules are a serious impediment to the kind of flexibility that the Federal Deposit Insurance Corporation has used so far in the US.
Which means that it all depends on whether this is a big crisis or a little one. In a little crisis, the fact that European banks are, currently, better regulated and less exposed to interest rate risk ought to protect them. In a real crisis, though, the faultlines of the European financial system will show up again, in unpredictable ways. The arc of financial history tends to organise itself to maximise embarrassment.