Banking shares dropped in Europe on Thursday as the instability that rippled through the global banking system this month is prompting investors to adjust to more challenging economic and lending conditions ahead.
The Federal Reserve on Wednesday indicated it was on the verge of pausing further increases in borrowing costs after the collapse of two U.S. lenders earlier this month triggered worries of contagion throughout the banking system.
Fed Chair Jerome Powell said the banking industry stress could trigger a credit crunch with "significant" implications for a slowing U.S. economy.
The turmoil that began in the United States spread quickly around the globe, ensnaring one of Europe's biggest banking names in 167-year-old Credit Suisse AG, which was forced into a shotgun marriage with Swiss peer UBS Group to avert a wider crisis.
Swiss National Bank Chairman Thomas Jordan said on Thursday the next two weeks will be vital to making sure the rescue was a success. Swiss authorities had urged the banks to come together and gave financial guarantees worth up to 260 billion Swiss francs ($280 billion) to get the deal done.
"At this moment the focus has to be that we can maintain financial stability and that the closing of the deal is smooth and fast," Jordan told a news conference after SNB hiked rates by half a percentage point.
The Bank of England was also expected to deliver its eleventh straight interest rate hike later in the day, even as financial stocks were among the top decliners on Britain's stock market.
Citigroup downgraded Europe's banking sector, warning the rapid pace of interest rate hikes will further weigh on economic activity and lenders' profits.
"The European banking sector's fundamentals look healthy. But the ongoing confidence crisis could limit banks' risk appetite and reduce the flow of credit," Citigroup equity strategists led by Beata M Manthey said.
The index of top European banks was down 2.1%, with German banking giants Deutsche Bank and Commerzbank falling 2.1% and 3.2%, respectively. London-headquartered HSBC dropped 3%.
BANK BOND PRESSURE
The rescue of Credit Suisse, which followed the collapses of California-based Silicon Valley Bank (SVB) and New York-based Signature Bank ignited broader concerns about investors' exposure to a fragile banking sector.
Switzerland's financial market regulator FINMA on Thursday defended its decision to impose steep losses on some of Credit Suisse bondholders as part of its rescue, saying the move was legally watertight.
The decision to prioritise shareholders over Additional Tier 1 (AT1) bondholders rattled the $275 billion AT1 bond market and some Credit Suisse AT1 bondholders are seeking legal advice.
The convertible bonds were designed to be invoked during rescues to prevent the costs of bailouts falling onto taxpayers as it happened during the global financial crisis in 2008.
"The AT1 instruments issued by Credit Suisse contractually provide that they will be completely written down in a 'viability event', in particular if extraordinary government support is granted," FINMA said.
Steep falls in banking stocks in the wake of the wipeout of Credit Suisse's AT1 bondholders prompted European supervisors to rush to defend the crisis-fighting tool.
Asian policymakers are also scrambling to calm investor nerves about AT1 bonds but the ongoing turbulence is likely to keep a lid on fresh debt sales.
Hong Kong and Singapore central banks said they would stick to the traditional hierarchy of creditor claims if a bank was to collapse in their respective jurisdictions.
However, the volatility may prompt at least two Japanese banks, Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group, to put AT1 issuance on hold, two sources told Reuters.
NO BLANKET SUPPORT
U.S. authorities have jumped to stem the turmoil this month by protecting the depositors of tech-focussed SVB, but U.S. Treasury Secretary Janet Yellen rejected expanding that protection more widely. Yellen told lawmakers on Wednesday that she has not considered or discussed "blanket insurance" for deposits without approval by Congress.
Her comments further pressured shares of beleaguered First Republic Bank, which lost much of its market value since the collapse of SVB and Signature Bank and which is speaking to peers and investment firms about potential deals.
Yellen's remarks came as Powell sought to reassure investors about the soundness of the banking system, saying that the management of SVB "failed badly," but that the bank's collapse did not indicate wider weaknesses in the sector.
The Fed's relentless rate hikes to rein in inflation are among factors blamed for the biggest banking sector meltdown since the 2008 financial crisis.
"The Fed is now living on a hope and a prayer that they haven’t done irreparable harm to the banking system," said Brian Jacobsen, senior investment strategist at Allspring Global Investments in Menomonee Falls, Wisconsin. "The Fed is probably thinking financial stresses are substituting for future rate increases."
Policymakers from Washington to Tokyo have stressed the turmoil is different from the crisis 15 years ago, saying banks are better capitalised and funds more easily available.
However, some watchers think the banking system is more vulnerable to rumour and rapid moves in an era of widespread social media use, posing a challenge for regulators trying to tamp down instability.
Social media is a "complete game-changer" in bank runs, Citigroup Inc chief executive Jane Fraser told the Economic Club of Washington D.C. on Wednesday.
($1 = 0.9280 Swiss franc)
(Reporting by Reuters bureaus; Writing by Toby Chopra Editing by Tomasz Janowski)