Tag: European Banks

Increased funding of European deposit guarantee schemes announced

On 17 June, the European Banking Authority (EBA), published 2018 data on national Deposit Guarantee Schemes (DGSs) across the European Economic Area (EEA), which show that 32 of 43 DGSs increased their funds available to cover deposits in 2018 by levying banks.

Here of course the $250k deposit scheme is unfunded and currently inactive.

Moody’s says that the target of 0.8% of covered deposits by 2024 set out in the Deposit Guarantee Schemes Directive (DGSD) has already been achieved in 17 of the 43 DGSs in the EEA. The gradually increasing harmonisation of DGSs in Europe is credit positive for European banks because it improves European banking systems’ financial stability by better protecting depositors against the consequences of credit institution insolvency. As DGS funding increases and exceeds the 0.8% threshold, they also expect banks’ levies to moderate, which will benefit their profitability.

Since the 2009 financial crisis, European authorities developed policies and tools to buttress financial systems’ resiliency and help authorities prevent and, if needed, tackle bank distress without having to resort to taxpayers’ support. DGSs form one of these tools.

Under current EU legislation, depositors are protected by their national DGS up to €100,000 (or the equivalent in local currency). This protection applies regardless of whether ex ante funding has been accrued by DGS. Under the DGSD, all EEA banks are required to contribute to national DGSs so that at least 0.8% of covered deposits are funded by 2024 (and by exception, no less than 0.5% of the covered deposits, like in France2).

Nine member states have set up DGSs with higher funding targets such as Romania (3.43%) and Poland (2.6%). Some countries, such as Iceland, have not yet defined their national funding target, while others have defined numerous DGSs for different categories of banks and depositors, as in Germany for private, public, savings or cooperative banks, hence there are more DGS than there are EU countries.

As of year-end 2018, 16 countries had already reached the DGSD’s 0.8% minimum funding ratio for 2024, and 10 countries exceeded their national target. The levies banks paid increased by around 12% in 2018, while covered deposits grew only by 3.6%. As of year-end 2018, EEA member states had reached in aggregate a funding ratio of 0.65% of covered deposits, up from 0.6% in 2017.

Out of the 31 banking systems addressed in the EBA report, 25 increased the funding for the DGSs in 2018, with very large increases in Ireland (+105.2%), Slovenia (+59.2%) or Luxembourg (+57.3%). The diversity in funding efforts reflects different starting points since some countries did not have DGS or limited ex-ante funding when the DGSD was adopted. For instance Luxembourg had no funding in 2015 and a target of 1.6% of covered deposits.

Despite progress, the third pillar of the banking union – the European deposit insurance scheme (EDIS) proposal adopted in 2015 – is not yet in sight due to a lack of political consensus. The EDIS proposal builds on the system of national DGSs and would provide a stronger and more uniform degree of insurance cover in the euro area. This framework would reduce the vulnerability of national DGSs to large local shocks.

EU Bail-in Rule Exposes Medium-Sized Banks’ Senior Creditors

The provisional agreement on minimum levels of bail-inable subordinated debt in the EU’s Bank Recovery and Resolution Directive (BRRD) may leave senior creditors of medium-sized banks more exposed if those banks fail, Fitch Ratings says. This could include, in extremis, wholesale depositors.

Minimum subordinated debt requirements may be amended to apply only to global systemically important banks (G-SIBs) and “top-tier” banks with assets above EUR100 billion, according to a statement from Gunnar Hoekmark, the EU Parliament’s rapporteur, on his website last Thursday. This would be consistent with a draft proposal discussed by the European Council in May.

As we noted in May, limiting bail-able debt requirements to the largest banks could mean medium-sized banks’ senior creditors miss out on the protection that subordinated debt buffers would provide. The agreement could make it more difficult to apply the EU’s bail-in framework to medium-sized banks, for example if there were legal challenges from bondholders that are bailed in while equally ranking creditors (such as wholesale depositors) are not.

Alternatively, if equally ranking retail bondholders and wholesale depositors were bailed in alongside institutional bondholders, this could create financial stability risks. The European Commission will assess whether all deposits should be preferred in an insolvency by December 2020.

The protection provided by minimum requirements is reflected in our bank ratings. Once subordinated bail-in and other unused debt buffers junior to preferred senior debt (for instance, unused additional Tier 1 and Tier 2) have been sufficiently built up, senior ranking debt can be rated one notch above the senior bail-inable debt.

The EUR100 billion cut-off is particularly relevant to less-concentrated banking systems, for example in Italy and Spain, and to smaller EU countries. For banks below the threshold, it could be challenging and costly to issue large amounts of subordinated debt, particularly for smaller banks that are less frequent borrowers in the debt capital markets. This is likely to explain why southern EU member states want to limit the application of minimum subordination requirements to avoid forcing any but the largest banks to build subordinated debt buffers.

For this reason, we expect the final rules will give national resolution authorities the option to request subordinated minimum required eligible liabilities and own funds (MREL) for banks which they deem systemic – but this will not be automatic, as it is for the top-tier banks and GSIBs. This will lead to variations in the approaches of EU member states to ensuring banks have sufficient loss-absorbing debt.

The provisional agreement to amend the BRRD also proposes a discretionary cap for the requirement for subordinated MREL at 27% of a bank’s total risk exposure. This would limit the associated costs for large systemic banks, but would leave their senior creditors less well protected in the event of outsized losses. The full rules, as part of the broader EU banking legislation package, are now likely to emerge before the end of this year.

ECB To Unwind QE

The European Central Bank said it plans to remove accommodative policy but the euro zone monetary authority had yet to discuss when interest rates would be raised.

The ECB decided to cut its monthly asset purchase program in half to €15 billion at the beginning of October and noted that it was expected to end in December – although reinvestment of proceeds will be maintained. They indicated that interest rates were likely to be on hold for an extended period of time.

“The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path,” the ECB said in its policy decision.

Reiterating that point in the press conference’s question and answer period, president Mario Draghi stressed the “at least through the summer of 2019” and added that “we did not discuss if and when to raise rates.”

The euro, which turned negative against the dollar when the decision was published, extended losses after those remarks.

Weaker short-term growth, stronger inflation

The ECB also updated its economic projections and predicted weaker growth along with stronger inflation for this year.

“June 2018 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.1% in 2018, 1.9% in 2019 and 1.7% in 2020,” Draghi announced. The 2018 growth forecast was cut from the 2.4% expansion predicted in March.

“The latest economic indicators and survey results are weaker,” Draghi explained, “but remain consistent with ongoing solid and broad-based economic growth.”

Overall, Draghi stated that the risks surrounding the euro area growth outlook remain broadly balanced.

However, he admitted that “uncertainties related to global factors, including the threat of increased protectionism, have become more prominent (and) the risk of persistent heightened financial market volatility warrants monitoring.”

With regard to price stability, the ECB now forecasts annual inflation of 1.7% through 2020, compared to the March projections of 1.4% for this year and next. The estimate for 2020 remained unchanged.

Draghi explained that the changes were made because the ECB felt that progress towards a sustained adjustment in inflation “has been substantial so far”.

“With longer-term inflation expectations well anchored, the underlying strength of the euro area economy and the continuing ample degree of monetary accommodation provide grounds to be confident that the sustained convergence of inflation towards our aim will continue in the period ahead, and will be maintained even after a gradual winding-down of our net asset purchases,” he added.

Bail-in May Become More Complex For Mid-Sized EU Banks

Proposed amendments to the EU Bank Recovery and Resolution Directive (BRRD) regarding minimum levels of bail-inable subordinated debt may make it harder to effect a bail-in resolution on mid-sized banks that run into trouble, Fitch Ratings says.

Minimum subordinated debt requirements may only apply to global systemically important banks (G-SIBs) and “top-tier” banks with assets above EUR100 billion, according to a draft paper to be discussed at a European Council meeting on Friday.

This EUR100 billion threshold to designate a top-tier bank would be at the top of the range previously proposed, and could make it more difficult to apply bail-in to mid-sized banks under the EU’s bail-in framework. This may be because of legal challenges from bondholders that are bailed in if equally ranking creditors (eg junior depositors) are not or because of financial stability risks of bailing in equally ranking retail bondholders and junior depositors alongside institutional bondholders.

The EUR100 billion cut-off is particularly relevant to markets with less concentrated banking systems, for example Italy and Spain, and to smaller EU countries. For banks below the threshold, it could be challenging and costly to issue large amounts of subordinated debt, particularly for smaller banks with a more limited footprint in the debt capital markets. Consequently, mid-sized bank senior creditors may miss out on the protection the subordinated buffers would have provided.

How widely minimum subordination requirements should apply has been a matter of contention. Some northern EU member states want a broader scope covering at least all of the “other systemically important institutions” (O-SIIs), to minimise contagion risk. Others, mainly southern EU member states, want to limit the application to avoid forcing any but the largest banks to build subordinated debt buffers. An amendment originally proposed by Belgian delegates provides resolution authorities with the option to request subordinated minimum required eligible liabilities and own funds (MREL) for banks deemed systemic – but this is not automatic, as it is for the top-tier banks and GSIBs.

The European Council’s draft BRRD paper also proposes capping for most banks the requirement for subordinated MREL at 8% of a bank’s total liabilities and own funds. This would limit the associated costs for banks, but would leave their senior creditors less well protected in the event of outsized losses.

Friday’s discussions will also seek to agree a timescale for banks to meet the new requirements. The draft proposes G-SIBs and top-tier banks will have until January 2022. Other banks subject to the requirements will be given until 1 January 2024, but some EU member states are seeking longer timescales as some banks may struggle to build buffers, particularly if they are deposit-funded and have not issued subordinated debt previously.

US RMBS Settlements Still Looming For Some European Banks

Uncertainty about the scale of penalties for US retail mortgage-backed securities (RMBS) practices more than 10 years ago will continue to weigh on some European banks’ capital management and dividends, Fitch Ratings says. They expect cautious capital retention to be a theme as the 2016 results season for European banks reaches its final stage.

The threat of large, unpredictable settlements hangs over a few European banks that have not settled yet, adding to the pressure on earnings and capitalisation from low interest rates and increased regulation. As a result, we expect banks will continue to prioritise cautious capital management and dividend policies, even though most have strengthened capital positions considerably since the financial crisis.

The US Department of Justice’s (DoJ) investigation into banks’ pre-crisis RMBS business has already cost USD31bn in cash settlements for eight of the global trading and universal banks. The DoJ examined the banks’ pre-crisis practices, including packaging, securitisation, marketing, sale and issuance of RMBS. European banks Deutsche Bank and Credit Suisse are the most recent to settle with the DoJ, agreeing to pay substantial fines of USD3.1bn and USD2.5bn, respectively, and to provide consumer relief.

Investigations into other European banks, notably RBS, Barclays, UBS and HSBC are ongoing. Barclays rejected a settlement in late 2016 and now faces a lawsuit. RBS, unlike other European banks, also still has a pending lawsuit with the US Federal Housing Finance Agency, which we estimate could add about USD3bn (based on an average past settlement rate of 10% of exposure) to any settlement with the DoJ.

Monetary fines have only constituted part of the settlements, and substantial amounts have been agreed in the form of so-called consumer relief, which we believe are proving far less punitive in financial terms. Consumer relief can include loan forgiveness, origination of lower cost loans and financing for affordable housing, targeted at the most vulnerable customers. Deutsche Bank has until 2022 to complete its USD4.1bn required consumer relief, and Credit Suisse until 2021, to complete USD2.8bn.

Pending regulatory and litigation settlements are factored into our analysis as a contingent liability. When a large settlement is reached, we assess the incremental cost in cash terms above provisions already booked and the affordability of the remainder through earnings. When a settlement will absorb at least two quarters’ earnings, we assess its impact on capital and the bank’s plans to remediate the capital effect.

We do not expect the outstanding investigations to lead to significant new restrictions on banks’ businesses or to damage their franchises. Banks have tightened conduct risk controls extensively in the period since the RMBS activity under investigation took place.