On Monday, European political and financial leaders moved to shore up consumer confidence following the crisis at Credit Suisse, Switzerland’s second largest bank. The emergency takeover of Credit Suisse by its competitor UBS and the difficulties of some smaller US institutions have fueled concerns about banks in the eurozone in the course of this week.
European advisors confirmed that in the event of a bank failure in the European Union, a fixed rule applies under which shareholders and other creditors are called upon. Bank losses would first be borne by share capital. If this is insufficient, subordinated bonds, so-called AT1 capital, are called in.
In the case of Credit Suisse, the holders of these equity-like bonds are to lose their invested money completely in the course of the takeover by UBS. For these AT1 bonds, the loss amounts to 16 billion Swiss francs (16 billion euros). Credit Suisse shareholders will also forfeit a large part of their invested money, but will receive UBS securities.
European Central Bank (ECB) President Christine Lagarde remained optimistic that there would be no spillover of the event on the eurozone financial system. The European banking sector was resilient thanks to strong capital and liquidity positions, Lagarde said. In the face of the current market tensions, the ECB was ready to support the financial system with liquidity if necessary, and to maintain the smooth functioning of monetary policy, she added.
Last week, the ECB had raised the key interest rate by 50 basis points despite the turmoil. In view of the current high level of uncertainty, the central bank did not commit itself for the future. Lagarde made it clear that the monetary guardians will be guided by economic data.
Within Europe, politicians and central bankers are at odds over the effectiveness of the ECB’s latest interest rate decisions.
Italy: ECB interest rate policy under scrutiny
Italian Economy Minister Giancarlo Giorgetti said on Monday that he believed the impact of the crisis at Switzerland’s Credit Suisse on Italy’s banking system would be “insignificant”. Referring to the market turbulences linked to Credit Suisse and, before that, to the collapse of the Silicon Valley Bank in the United States, he said he believed that the markets had calmed down a bit. “I think that the situation in Europe is under control. We are in constant contact with the regulatory authorities and we are tranquil about the Italian banking system.”
The Milan stock exchange plummeted 2.6 percent in early trading on Monday, with bank stocks taking a fresh pounding after over a week of turbulences on the international money markets. The rescue of Credit Suisse announced over the weekend had failed to dispel investor concerns. On Tuesday, the Milan exchange closed 2.53 percent up, as bank stocks rallied strongly from recent losses on Silicon Valley Bank and Credit Suisse.
Giorgetti also reiterated his criticism of the European Central Bank’s policy of hiking interest rates to combat high levels of inflation. “[The policy] should be calibrated with great care because increasing interest rates might be useful to control inflation, but it can also cause problems for financial stability,” he said.
The ECB’s decision to increase the key interest rate by 50 basis points leaves the Italian government unsatisfied. “The ECB is not moving in the right direction, even if today there was a start of rethinking. In our opinion, it is not a good way to deal with inflation,” said Deputy Prime Minister and Foreign Minister Antonio Tajani.
France: Basel III rules saved the day
European banks were in “extremely solid” shape and their situation was not similar to that of some US lenders, François Villeroy de Galhau, governor of the Banque de France and a member of the ECB’s governing council, said last week amid fears of a crisis in the sector.
“European banks are not in the same situation as certain American banks for a very simple reason, which is that they are not subjected to the same rules,” he added. Rules known as Basel III that were created after the 2008 financial crisis to ensure that banks had adequate capital and liquidity had been “effective”, Villeroy de Galhau said. He added that 400 European banking groups were subject to the Basel III requirements, compared to only 13 in the United States.
Under Donald Trump‘s presidency, small- and mid-sized US banks had been exempted from the Basel rules in 2019, he said, noting that both Silicon Valley Bank and Signature Bank, which collapsed last week, were among those. The French central bank governor explained that Credit Suisse was a special case. “It’s a bank that has both business model difficulties” as well as “failures in its internal control system,” he said.
While the ECB said it stood ready to provide liquidity to ensure the stability of the eurozone’s financial system, it stuck to a hefty interest-rate hike of half a percentage point to mitigate inflation, despite fears that rising borrowing costs may add further stress on banks. Villeroy de Galhau said the ECB’s move sent a “strong” sign of confidence in its anti-inflation strategy and the solidity of European and French banks.
Slovenia, Bulgaria and Germany maintain a calm attitude
On Monday, the Bank of Slovenia said that the European and Slovenian banking systems were operating strongly, notwithstanding the turmoil in the US and Swiss banking systems. “The euro area banking sector is resilient, with strong capital and liquidity positions,” the Slovenian Central Bank added.
According to the reassurances by the Bank of Slovenia, the range of the European Central Bank’s monetary policy instruments is sufficiently broad to provide liquidity support to the financial system when needed.
Bulgarian Interim Finance Minister Rozita Velkova commented that at this point there was no risk of a contagion for Bulgaria from the bank failures in the US.
Senior financial analyst at MoitePari.bg Desislava Nikolova noted that the ECB’s interest rate hikes, which started in 2022, had not affected the banking market in Bulgaria because of its strong liquidity. The country had sufficient resources to slow down the processes related to interest rate hikes, she said. Not being part of the eurozone, Bulgaria has kept the lowest lending and deposit interest rates, Nikolova said. She expects that instead of a more gradual rise in interest rates, Bulgaria may now see a faster increase because in macroeconomic terms, the latest developments caused uncertainty.
On Monday, German Chancellor Olaf Scholz welcomed the “decisive action of the Swiss authorities” in the takeover of the ailing Credit Suisse by its competitor UBS, a government spokesman said. European authorities had learned from the 2008 financial crisis and tightened banking regulations, he stressed. “The German banking system is therefore well positioned,” the spokesman added.
End of ECB interest rate hikes not yet in sight
According to the President of the German Bundesbank Joachim Nagel, who sits on the ECB’s Monetary Policy Council, the ECB has not yet reached the end of its interest rate hike course. At the same time, he said in an interview with the Financial Times, interest rates were approaching the restrictive range. Economists consider this to be the level at which interest rates start to slow down economic activity.
Nagel stressed that the ECB would have to resist calls for early interest rate cuts once the interest rate peak had been reached. Otherwise, he said, high inflation threatens to flare up again. “Our fight against inflation is not over,” said the chief of Germany’s central bank.
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