Banking shares have slipped in Europe as the instability that surged through the global banking system prompts 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 United States 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 US economy.

The turmoil that began in the US 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.

Citigroup downgrade

Citigroup downgraded Europe’s banking sector on Thursday, 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 1.0 per cent in early trading, with German banking giants Deutsche Bank and Commerzbank both falling 0.8 per cent.

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.

Legally watertight

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 decision was legally watertight.

The decision to prioritise shareholders over Additional Tier 1 (AT1) bondholders rattled the $US275 billion ($A409b) 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 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.

US jumps to stem turmoil

US authorities have jumped to stem the turmoil this month by protecting the depositors of tech-focused SVB, but US 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.

“These are not weaknesses that are running broadly through the banking system,” the Fed chair said, adding that the takeover of Credit Suisse seemed to have been a positive outcome.

Relentless rate hikes

The Fed’s relentless rate hikes to rein in inflation are among the 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.

-Reuters

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