The Bank of England has asked large British lenders to detail their current exposure to Deutsche Bank and some of the biggest Italian banks, including Monte dei Paschi, amid mounting market jitters over the health of Europe’s financial sector.
The request was made in recent weeks by the BoE’s Prudential Regulation Authority as investors sold off Deutsche and Monte dei Paschi, both of which have been the subject of scrutiny over their capital levels.
Supervisors worldwide have attempted to curtail the links between large institutions since the 2008 banking crisis, when the collapse of Lehman Brothers and other big groups threatened to drag down the entire global financial system.
The PRA now regularly speaks to banks about their exposures, particularly to any lender that might be facing difficulty. Over the past few years, the BoE has asked about UK-headquartered lenders’ exposure to Greek banks, for example.
But the BoE’s recent intervention is a sign of continued nervousness among regulators that the interconnectedness of Europe’s largest banks could harm otherwise healthy groups if one of the weakest links were to fall into crisis. The PRA declined to comment.
Normally, exposures to other financial institutions are not disclosed to regulators unless they are particularly large or as part of annual stress tests. That forced the BoE to ask for the latest snapshot of the big UK banks’ exposures to their German and Italian rivals as those groups came under market attack.
Deutsche shares dropped nearly 12 per cent last month amid fears it would have to pay the US Department of Justice $14bn for mis-selling mortgage securities. Monte dei Paschi, which is considered the most stressed large bank in Europe, lost 23 per cent.
Banks can be exposed to one another directly through lending or derivatives but indirect exposures — such as lending to a counterparty of a bank in trouble — also need to be considered.
During the financial crisis, the old City regulator, the Financial Services Authority, was pushed to make banks disclose more about their holdings in one another as authorities tried to limit contagion roiling the markets.
Global rules cap the amount that one bank can hold in another to 25 per cent of the first bank’s capital, while anything above 10 per cent must be disclosed to regulators. Smaller holdings are therefore harder for supervisors to spot.
Paul Sharma, a former PRA official now a consultant at Alvarez & Marsal, said large UK banks were now able to monitor their direct exposure to troubled banks on a “near real-time” basis but that market turmoil could complicate the picture.
“A more serious concern would be the indirect exposure to UK banks from the disruption to financial markets that might occur if a major European bank were to fail,” Mr Sharma said. “This is far less easy to quantify.”
The International Monetary Fund earlier this year labelled Deutsche Bank as the riskiest bank globally, with its investment and banking units making it highly interconnected with the rest of the financial system.
British regulators are particularly anxious about the impact of litigation costs on Deutsche’s already weak profitability and that large piles of non-performing loans could have a similarly corrosive impact on Italian banks.
Deutsche Bank shares fell to three-decade lows last month after it confirmed receiving the $14bn demand from the justice department; no final settlement has yet been agreed but Deutsche executives have insisted the fine will be far lower.
Germany’s biggest bank still faces serious doubts on whether it will need to raise billions of euros of extra capital and slash costs drastically to strengthen its balance sheet and boost profits.
Analysts expect Deutsche to post a net loss of €610m when it reports third-quarter results on Thursday, largely because they expect the bank to take another large slug of litigation provisions ahead of a potential settlement with the DoJ.
Analysts are split on precisely how much the bank will set aside, but their forecasts range from €250m to €1.5bn according to a consensus report compiled by the bank.
Other unresolved conduct scandals still loom for Deutsche, including a probe into whether so-called mirror trades were used to skirt sanctions for some of its Russian clients.
Monte dei Paschi this week unveiled its plan to raise €5bn of extra capital through a mixture of issuing new shares and swapping debt for equity.
Additional reporting by James Shotter in Frankfurt
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