LONDON (Reuters Breakingviews) - The wrath of regulators is shifting away from banks. Big lenders spent the past decade atoning for the 2008 financial crisis. The coronavirus-induced meltdown has tested the resilience of a reformed industry, while revealing the fragilities of financial markets. Banks will reap the benefits.
In 2008, thinly capitalised and poorly run banks were the villains in the crisis. This time, the strain has been felt mainly by exchange-traded funds, collateralised loan obligations and other vehicles that ballooned in the past 12 years. As Covid-19 spread, those investors fled.
Banks remain remarkably unscathed by the global dash for cash. The biggest blunder to date is ABN Amro Bank’s $200 million loss after a client got into trouble. The Dutch lender’s setback is tiny compared to the multi-billion dollar debacles Morgan Stanley, UBS and others suffered in 2008.
Regulators deserve much of the credit. They spent a decade making banks more resilient. The thinking was that funds and other non-bank entities were better repositories for risky debt, because they have less leverage and don’t gather public deposits. Their failure won’t threaten to drag down the system.
The shift is visible in Financial Stability Board data. By the end of 2018, banks’ share of financial assets had fallen below 40%, from 45% a decade earlier. Debt held by “other financial intermediaries” almost doubled to $114 trillion over the same period, reaching more than 30% of the total.
Covid-19 has exposed the vulnerabilities of the regime. As markets tumbled, ETFs dumped their holdings, including less liquid assets such as corporate bonds and commodities. A vast edifice of corporate debt is wobbling. Bonds rated BBB – the lowest investment-grade rating - account for roughly half of all investment-grade corporate debt in the United States and Europe, according to the International Monetary Fund. Some investors were forced to sell after big borrowers like Ford Motor and Kraft Heinz lost their investment-grade ratings.
That’s why central banks have rushed to prop up markets. They announced plans to buy corporate bonds worth billions of dollars and unclogged the market for commercial paper. The Federal Reserve is even buying some junk-rated debt.
Those interventions have halted the panic. But as the last crisis showed, the beneficiaries of support will pay a price. Large fund managers like BlackRock and other financial intermediaries will face greater scrutiny, and possibly tighter rules.
Banks meantime are showing other virtues. Lenders can grant payment holidays or waive debt covenants for borrowers. Bond investors, whose holdings tend to be governed by legal contracts, are less flexible. Banks are also the main conduits for distributing government-guaranteed loans, especially to small and medium-sized companies.
Acting as instruments of policy isn’t risk free: Supervisors at the European Central Bank and Bank of England have instructed banks not to pay dividends or buy back shares this year. Fat bonuses will also be taboo.
The quid pro quo may be regulatory relief. The Fed, Switzerland’s Finma and European Union authorities have temporarily relaxed the calculation of the leverage ratio - a key capital constraint. Meanwhile the Governors and Heads of Supervision, which oversees the Basel Committee of global banking regulators, deferred tighter capital rules by a year.
Supervisors have dulled the effect of tough new accounting standards by encouraging banks not to set aside too much cash for bad debt. European authorities could deliver a further benefit by allowing banks to include some intangible software assets in their capital calculations.
The next step might be to encourage consolidation. The most likely deals would see stronger names like Britain’s Lloyds Banking Group mop up sub-scale peers such as Virgin Money. America’s scores of regional lenders could use the crisis as a spur for more dealmaking, while cash-squeezed fintechs may flee into the arms of the incumbents they hoped to disrupt.
Société Générale Chief Executive Frédéric Oudéa said he’s interested in cross-border M&A. Perennial pairings like BNP Paribas and Deutsche Bank may be back on the table, pitched as regional champions to rival U.S. megabanks. The first step to making such deals plausible would be easing restrictions that stop banks from moving deposits across European borders. The pandemic may finally persuade sceptical national governments such changes are necessary.
Banks still face plenty of challenges. Lockdowns will lead to bad loans which will eat into capital. Ultra-low interest rates will further squeeze profitability. Nevertheless, the sector that helped cause the last crisis is proving itself an essential tool in fighting the current one. The prize will be more sympathetic regulators on the other side.
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