by Theo Bourgery-Gonse
The collapse of Silicon Valley Bank (SVB) in the US only has a “limited impact” on EU markets, and the EU banking sector remains “in good shape”, financial services Commissioner Mairead McGuinness told lawmakers on Wednesday (15 March).
Three US banks – SVB, Silvergate and Signature – failed over the weekend due to a downturn in the US crypto and tech sectors, followed by liquidity traps as they ran out of cash to pay back deposits from corporate clients.
“The direct impact on the EU seems to be limited,” McGuiness said, adding that EU markets’ reaction was “initially negative, but has since calmed down”.
The European index of banking shares (.SX7P) fell 7%, with more than $126.5 billion (€120 billion) of market value evaporating since last week, according to Reuters estimates.
The banks invested deposit money to buy long-dated assets, which lost a large portion of their value once the Federal Reserve (Fed) hiked interest rates. This fairly-common financial move is only sustainable if banks manage (‘hedge’) their risks – which these three banks did not do.
A regulatory failure
The banks’ mismanagement of balance books can be explained by the US’s non-application of Basel III prudential requirements to small and mid-size banks, McGuinness added.
Basel III requirements are a set of internationally-agreed standards that, in a nutshell, seek to determine the minimum level of free cash a bank must maintain to deal with unexpected losses.
“When the Fed implemented Basel III in October 2020, they took advantage of the fact that strictly speaking, the Basel Accords are only internationally agreed to apply to ‘large, internationally active’ banks,” Daniel Davies, managing director at Frontline Analysis, wrote in the Financial Times.
“While most jurisdictions apply the Basel rules to their entire banking system anyway, the US has a strong and powerful community bank lobby [which pushed back against applying the requirements on smaller banks],” he explained.
In practice, this means those US banks, notwithstanding their exposure to a market as volatile as the tech market, did not have the necessary collateral to pay back deposits. Regulators did not have the necessary oversight to see the storm coming.
As such, the EU’s financial services chief put on a reassuring tone: “In the EU, we do apply the Basel prudential standards to all banks” – a statement she repeated three times.
Earlier this week, French Economy Minister Bruno Le Maire had also encouraged market actors to “calm down”.
Higher capital buffers
Negotiations are already underway in the EU over applying higher capital buffers for EU banks, to better comply with Basel III standards.
Banks usually use internal models to calculate the risks of their assets, which then determines the needed capital buffers. To counteract the banks’ temptation to under-calculate the risk in their internal models, the Commission proposed an “output-floor” that sets a minimum requirement for bank capital.
“In light of what happened, we must be able to revise, negotiate and ensure that we understand the extent to which the EU is able to apply Basel requirements,” Jonas Fernandez (S&D), a leading MEP on financial services matters, told the plenary.
The banking legislative package, first introduced by the Commission in October 2021, is entering the inter-institutional ‘trilogue’ stage.
“Though we apply the same rules to all banks, the EU does not apply all of Basel III’s requirements,” Fernandez said, calling on the Commission to put together a new legislative proposal to better manage bank failures.
McGuinness also contended that more work should be done for effective regulation of third-country bank branches that are established in the EU, adding that she was closely monitoring the current situation, especially contagion risks in EU markets.
“We have to stay alert to this new environment,” she said.
Harder financing for tech startups
EU lawmakers warned this financial crisis would have a lasting, negative impact on tech start-up financing, as banks shy away from more risky market segments.
The EU regulatory system works as a “dyke” that protects the European financial system from contagion and provides for greater financial stability, at the cost of easy financing for tech companies, MEP Stephanie Yon-Courtin (Renew) told EURACTIV. “The US have less stringent rules, but have more financing firepower”.
“What we got from the US is free-of-charge alarm bells. This is no time to let go of regulatory checks, in spite of higher financing costs for tech startups,” MEP Marek Belka (S&D) added.
The alarm bells might be ringing even louder now, however.
Only a few hours after the parliamentary debate, the banking crisis seemed to have come a little closer already. With market confidence in the scandal-ridden Swiss bank Credit Suisse tanking, the Swiss National Bank saw itself forced to issue a statement saying it would support the large Swiss bank with liquidity in case of an emergency.
The coming days and weeks will show whether the European “dykes” hold.
*first published in: Euractiv.com