Too-big-to-fail rules remain sufficiently robust despite recent turmoil in the banking sector and do not need to be reworked, ECB Chief Banking Supervisor Andrea Enria said March 28.
The collapse of US-based Silicon Valley Bank and investor doubts about Credit Suisse Group AG, which ultimately led to a regulator-brokered merger with Swiss peer UBS Group AG, hit European bank stocks, subordinated bond prices and credit default swap (CDS) spreads, fueling contagion fears and raising questions about potential rule tightening. Business models, risk controls and the opaqueness of CDS transactions are under the spotlight.
"Market turmoil always triggers political debates on regulatory reforms, but I think we should rather focus on the effectiveness of supervision," Enria said, speaking at the Handelsblatt Annual Conference on Banking Supervision. Restarting the debate on regulatory reforms "would not be productive" as bank supervisors have all the tools they need with the implementation of the final Basel III capital reforms, Enria said.
"I remain confident that the rule book that we have, [including with regard to] resolution, is strong and would work in practice," Enria said.
Swiss Finance Minister Karin Keller-Sutter had earlier told Swiss newspaper NZZ, while defending the emergency rescue of Credit Suisse, that following global rules for winding down too-big-to-fail banks would have triggered a wider crisis, the Financial Times reported.
CDS market transparency
Enria called for more transparency in the CDS markets, where "with a few millions" of investment "you can move the CDS spreads of a trillion-euro-assets bank," affect the cost of funding and possibly trigger deposit outflows.
The Financial Stability Board should consider reviewing "how these markets really work," Enria said. Having these types of derivative transactions centrally cleared rather than through over-the-counter deals, where you do not know who is trading, would represent great progress, Enria said.
Germany's largest lender, Deutsche Bank AG, experienced a surge in CDS spreads and a double-digit drop in stock price on March 24 after a week of market tumult following the forced Credit Suisse-UBS merger on March 19. The deal sparked questions about bank resolution rules, as Additional Tier 1 notes at Credit Suisse were wiped out, while some shareholders' equity was preserved.
"A bad day in the stock market can always come and that is not a source of concern," Enria said regarding Deutsche Bank. Yet current investor nervousness about the banking sector is a reason to worry, he said.
Any ban on the short selling of bank stocks would need to be a "tool of last resort" for the responsible authorities, and such a task would not fall on Enria and his team as prudential supervisors, he said.
Contagion
Direct exposure contagion was irrelevant for Silicon Valley Bank and relevant but manageable for Credit Suisse. Contagion via market interconnectedness was minimal for Silicon Valley Bank, but very relevant for Credit Suisse, Enria said.
The Credit Suisse AT1 case had a knock-on effect on eurozone banks' debt securities prices as investors perceived the notes' wipeout as a reversal of the usual creditor claims hierarchy. This reversal would not happen in the EU because AT1 instruments in the EU do not have the same type of supervisory triggers.
The Credit Suisse notes write-down was triggered by a viability event rather than insufficient common equity Tier 1 capital, which is a common AT1 trigger for converting the debt to equity.
Business model viability
US-based Silicon Valley Bank was an outlier with an unusual business model, a concentrated depositor base and "extreme" interest rate risk, and there was no read-across to European banks, Enria said.
ECB supervisors have been "quite vocal" about the viability of business models and may need to be more so, but intervention is difficult for supervisors whose remit it to design rules for balance sheet fundamentals rather than dictate how banks conduct their business.
"We can tell [banks] we see something that doesn't work, but we cannot tell them in which areas of business they should focus," Enria said.
