The year 2022, with the invasion of Ukraine, the energy crisis and the change of direction of the European Central Bank was very complicated, but even so, the capital and liquidity positions of the supervised credit institutions in the Eurozone are solid and very above the minimum requirements, with an average CET 1 capital ratio of 15.3% (14.7 at the end of the fourth quarter) and a liquidity coverage ratio of 161%. In addition, the volume of non-performing loans has continued to fall (1.8%) and the return on equity reached its highest level since the start of the banking union, standing at 7.7%. Having said that, and in light of the storm of recent weeks, triggered by the fall of two medium-sized entities in the US and the resolution of Credit Suisse shortly after, it shows the importance of not lowering their guard, of banks watching their Funding sources and managers should be very careful about possible “simplistic and obsolete strategies” in the face of rate hikes and monetary tightening, as they can become an “existential threat.”
That is the message that the Single Supervisory Mechanism (SSM) and its head, the Italian Andrea Enria, have conveyed this Tuesday, in the presentation of its first annual report and in an appearance before the Committee on Economic Affairs of the European Parliament in Brussels. a few hours later. Enria wanted to convey confidence, in the same vein as Christine Lagarde the day before in the same place. He has defended the solvency of the entities, the liquidity lines and the efforts of recent years, he has maintained that the jobs have left a sector in a much better state than in the past and ensured that the exposure to what happened in California and in Switzerland is minimal, just a few million euros in the worst case. But he has urged to be careful and that there be no “surprises” due to the interest rate rises, which, although they have initially helped banks to record record profits, are also having a negative impact on the quality of certain assets. and in the valuation of public debt portfolios on balance sheets.
The strength of bank balance sheets has been a crucial factor in weathering the turbulence that has materialized in the banking and financial markets in recent weeks, but “although the rapid adjustment in interest rates allowed the banking sector to reached record levels of profitability and improved its market valuations, it also gave rise to the need to proactively manage risk for these rates, financing risk and liquidity risk,” the supervisor told MEPs.
“Rises in interest rates and quantitative tightening require banks to focus more attention on liquidity and funding risks. If banks do not rapidly adapt their risk management and strategic direction capabilities, an environment More difficult financing could call into question overly simplistic and clearly outdated asset and liability management strategies, such as the carry trade activities adopted by some banks to take advantage of extraordinary monetary policy support. banks unprepared”, warned Enria. “The failure of some midsize US institutions reminds us that the specifics of a bank’s business model can make its balance sheet particularly vulnerable to interest rate risk. In extreme cases, this can transform rate hikes from momentum for profits to an existential threat,” he said in Brussels.
AN IMPOSSIBLE RESOLUTION IN EUROPE
The attention of legislators these days, and of the markets in general, is on what has happened in Switzerland and what lessons to draw. The SSM issued a statement these days, together with the European Banking Authority, making it clear that a resolution like the one Credit Suisse has suffered is impossible and unthinkable in Europe. Enria has maintained the message, with criticism in the same direction for the US, because both countries have loaded in a few days the framework that emerged from 2008, which establishes steps and priority levels when it comes to suffering losses. The US decided to bail out all depositors and not just those who had less than $250,000 in their accounts, and Switzerland opted to fully debit Credit Suisse bondholders, including those who have convertible bonds (the famous CoCos) despite the fact that the shareholders will save part of their investments.
Calling on EU legislators not to allow or consider deviations from Basel III international standards, Enria has defended the EU system, which would have punished shareholders before those who have coconuts, instruments that in case of problems for a bank are converted into equity, into shares. “This approach has been applied consistently in previous cases and will continue to guide the actions of the Single Resolution Board and European banking supervision in all crisis interventions,” she concluded.
Likewise, the supervisor has ruled out that the ECB is considering placing limits on the distribution of dividends or the repurchase of shares, despite the volatility and movements these days. Some entities have already announced both operations for this course, and in greater numbers and volume than in the past, and Enria has insisted that they “have no intention” to prevent it. “The ECB is not considering a distribution cap. We have already reviewed the plans and in general nothing has changed to affect our assessment,” he added.
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