SVB less likely to affect financial health of European banks: Moody’s

By Puja Sharma

The Moody’s report discusses the implications of SVB’s collapse on European banks. European banks’ bond portfolios have been suffering from a sharp decline in market value as interest rates have risen since early last year. These declines in value are temporary and moderate for most large European banks. Smaller, deposit-funded banks can rely on the stability of their loyal depositor bases, which ensures they can wait for a recovery in bond values without incurring materially higher funding costs.

Euro-area banks hold mostly bonds issued by sovereigns and financial institutions, both as investments and as liquid assets that they can sell quickly if funding sources temporarily seize up. Securities portfolios on average make up around 12% of their total assets and represent around 175% of capital and reserves.

Long years of low or negative interest rates mean that the vast majority of these bonds carry very low fixed-rate coupons. As market interest rates rise, the low annual returns quickly look meagre when compared with newer investment products carrying higher interest rates.

Monetary tightening likely still has some way to run, and developing stresses in the US banking system will also weaken investor confidence and heighten funding tensions for European institutions that, as with any bank, by construction combine maturity mismatches with leverage. These effects are magnified when rates increase faster than expected, which causes some fixed-rate assets to fall in value and liabilities to start repricing upward more quickly than assets roll off and are replaced.

However, 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. While European banks’ debt securities grew by 10% in the 12 months to June 2020, it was their cash placed at central banks that ballooned, in response to the ECB’s TLTRO programme and the resulting arbitrage opportunity available. This has resulted in some structural differences between the Euro area and US banks.

These critical differences do not make European issuers invulnerable. When confidence is punctured, contagion can be rapid. Banks’ balance sheets are by definition leveraged, run maturity mismatches and are often complex and opaque, with interlinkages and exposures that are often only known after the event. In addition, the ECB likely has further to run in its tightening cycle than the Federal Reserve, and although close to half of the TLTRO has now been repaid, this leaves €1.2 trillion outstanding that has to be withdrawn. So the full effects of monetary tightening may yet lie ahead

Cash at central banks is a bigger part of European banks’ balance sheets, and debt securities are a smaller part. Debt securities are about 12% of euro area bank balance sheets, versus over 30% for US commercial banks, and about 40% of Euro area banks’ holdings are government securities, versus about 80% of government and agency securities for US banks. EU banks are also subject to capital requirements on interest rate risk in the banking book. This means that European banks have less exposure to market risk on bonds, despite a similar rise in yields on the five-year benchmark from 2020 lows.

Key Trends :

•  Deposits are likely to be more stable in Europe, having grown far less rapidly in the first place, and all EU banks are subject to liquidity coverage ratio requirements.
• Cash at central banks is a bigger part of European banks’ balance sheets, and debt securities are a smaller part.
• Strong cash balances at central banks totalling 16% of assets means European banks are less likely to require recourse to selling securities and realising any losses.
• Both the BoE and ECB have well-developed contingent liquidity facilities which are actively utilised by the banks.