Financial stability in times of uncertainty
The Governor of the Bank of Spain, Pablo Hernández de Cos, in a recent speech, pointed out that the idiosyncratic elements (of SVB and Credit Suisse) that led to their resolution and sale are not present in European or Spanish banks and, therefore, the experience of these institutions cannot be mechanically transferred to our banking sector as a whole. The regulatory reform agreed at international level in the last decade which, in the case of Europe, has been applied to all banks, irrespective of their size (this is not the case in the United States), has strengthened the capital and liquidity base.
Main takeaways from the speech:
- The Governor provided an overview on the lates financial events: In the US, the deterioration in the financial situation of some medium-sized banks in the United States, which has led to the resolution of Silicon Valley Bank (SVB), and the acquisition of the Swiss bank Credit Suisse by UBS, with the support of the Swiss government, have increased investors' risk aversion and financial market volatility, and led to a global decline in the stock prices of the banking sector.
- In the case of SVB, it had a high concentration of its loans and deposits among venture capital, fintech and start-up companies, with a high reliance on wholesale deposits for funding, and most of its assets consisted of fixed income securities whose potential losses were not reflected in equity and incurred in significant losses on early sales due to liquidity constrains. In Switzerland, in the case of Credit Suisse, a global systemically important institution that had relevant losses linked to its investment banking business and which had been subject to significant liquidity withdrawals in the last quarter of 2022.
- According to the Governor, these situations does not apply to banking in Europe and Spain where banks (regardless the size) are subject to the same strict capital and liquidity requirements.
- The orientation of the Spanish banking system to the retail segment has recently contributed to a positive evolution of profitability (which has even exceeded the cost of capital) in a context of rising interest rates and a favorable liquidity position. The weight fixed-income instruments portfolios in the Spanish banks' balance sheets is similar to that of other European banks and is well below that held by the SVB.
- In the European Union we have a resolution framework that we have already consistently applied on several occasions. This framework clearly sets out the order in which shareholders and creditors of troubled institutions should absorb any losses (shareholders and reserves of the institution before AT1 instruments, unlike in Switzerland).
- In conclusion, the Governor states that the swift and decisive decisions taken by the US and Swiss authorities have been essential to ensure financial stability and to restore appropriate market conditions, and it will be necessary for our banks to pursue a prudent provisioning and capital planning policy, allowing part of the increase in profits that is taking place in the short term to further increase the resilience of the sector. Additionally, the Governor argues that we need to complete the banking union, with the creation of a fully mutualized European deposit guarantee fund. A commitment to establish such a mechanism would have a considerable impact on the confidence of citizens and markets.