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European Banking System: Not a Simple Game of Dominos

Given the recent volatility in the Banking sector following the collapse of a few U.S. mid-sized to small banks causing concerns over the potential for a financial crisis, Cushman & Wakefield Research provides its analysis on what this means for Europe and the commercial real estate sector. 

This analysis was published on 27/03/2023. Given the fluidity of the situation; Cushman & Wakefield will provide updates as pertinent information becomes available. 

#1 Is Europe at Risk of Contagion?

Probably not. Credit Suisse should not be seen as a domino falling in reaction to what has happened in the U.S., nor should it be viewed as a suggestion that a systemic sequence of failures is expected. For contextual background, Credit Suisse has been plagued by a series of scandals and financial losses unique to its own history, and its challenges were unrelated to the interest rate risk and flight of uninsured depositors that several U.S. regional banks are confronting (including those that failed in recent weeks). 

Credit default swap (CDS) prices for Credit Suisse underscore the known and very unique circumstances and problems facing the bank for some time. Its CDS price had gapped out significantly compared to other major European banks in recent days. For example, the average CDS price for a major U.S. or European bank was up 55% between March 1, 2023 and March 16, 2023. For Credit Suisse, it was up over 216%. 

Although Credit Suisse has a long timeline of misfortunes, the latest “longer-term” sell-off in Credit Suisse's shares began in 2021, with the collapse of investment fund Archegos and Greensill Capital. To add to their troubles, Saudi National Bank, which, after investing $1.5 billion in November 2022, was the largest shareholder of Credit Suisse with 10% of shares, reported publicly that it will not be investing more money into the bank due to its own regulatory constraints. Credit Suisse ranks amongst the world's largest wealth managers whose failure would have caused huge ramifications for the entire financial system, which is why Swiss financial authorities were quick to release a statement of support confirming the country’s central bank would provide it with liquidity if necessary. Such swift reassurance was not enough to calm market unease and, as a result, Swiss authorities had to look for a private sector solution. A competitor of Credit Suisse, UBS, stepped in to rescue the bank, spending $3.25 billion, creating the world’s fourth-largest bank by assets. 

Who’s Next and What Does This Mean for the Wider Banking System? 

The big question on everyone’s mind is whether there are other institutions under stress which may be vulnerable to difficulties due to market conditions. (Note that this concern, while natural and legitimate, is very different from those relating to U.S. issues and those relating to issues specific to Credit Suisse). As Warren Buffett once said, “it’s only when the tide goes out that you see who really is vulnerable.” The speed at which last week’s events unfolded shows us that this is difficult to anticipate in advance.  

European banking stocks have taken a battering lately but share prices can be reflective of sentiment rather than the strength of balance sheets. Financial markets can be highly sensitive to every headline which means any 1% movement (that is justified) can quickly turn into a 2% move; fortunately, at the time of this writing, European market sentiment was boosted by central banks offering support as and when needed. However, there are likely to be periodic episodes of concern around banks as we adjust to higher interest rates, slowing growth and in some cases, as investors price bank-specific idiosyncrasies. 

The European Banking System Is Sound, and Well-capitalised: 

  • Regulation and stress tests: European banks have been subject to much stricter liquidity rules since the 2008 Global Financial Crisis (GFC). In particular, the ‘Basel III’ requirement introduced minimum capital requirements, and holdings of liquid assets aimed to strengthen bank capital requirements to deal with unexpected losses. 
  • European banks’ government bond holdings are much lower than those of U.S. Banks: According to Bloomberg Intelligence, European banks have €1.6 trillion ($1.7 trillion) of government bonds on their balance sheets, this accounts for less than 10% of all assets for most large European banks. This contrasts with U.S. banks, where securities (largely Treasuries or GSE-sponsored) comprise around 20% of total assets.  
  • European banks have a buffer to absorb any immediate need for liquidity: With 16% of European banks’ assets held in cash with various central banks, this provides flexibility to react to any immediate need for liquidity. This is on par with large U.S. banks—those with over $250 billion in assets—who also have 14% of assets in cash, while quasi-regional, regional and community banks in the U.S. have less cash on hand. It may be important to note here that the European banking system is not comprised of thousands of small community banks like it is in the U.S. The number of small banking institutions has been declining as a result of large-scale mergers; smaller banks make up approximately 18% of total euro area banking assets and are concentrated in a limited number of countries (Germany, Italy, Luxembourg and Austria). Rather, there are several major banks in Europe which provide ample information about the health of the broader banking sector. 
  • European banks’ funding is diversified: Around 60% of European banks’ assets were made up of loans to retail and commercial customers, followed by cash balances, which make up 16% of assets, and debt securities, which comprise 12%. 


#2 How are Central Banks Trying to Avert a Banking Crisis? 

In response to the COVID-19 pandemic, six central banks—the Bank of England, Bank of Japan, Bank of Canada, the European Central Bank (ECB), the Federal Reserve and the Swiss National Bank—came together to announce a mechanism referred to as a ‘swap line,’ which is essentially an agreement between two central banks to exchange currencies. This program was recently reinstituted and will remain in place until the end of April 2023, with the Federal Reserve now offering daily currency swaps, rather than weekly, enhancing the provision of liquidity of U.S. dollars to the global economy. This allows a central bank to acquire foreign currency liquidity from the Federal Reserve so they are able to provide this to domestic commercial banks. This mechanism provides liquidity quickly to mitigate stresses on the supply of credit by maintaining the flow. This is particularly important for some European banks that have borrowed in dollars to finance their dollar-denominated transactions. As banks can only borrow from their domestic central bank, these swap lines will mean central banks are able to provide liquidity in their own currency as well as foreign currency, ensuring borrowers are able to repay their loans during times of financial stress.  

How do Central Bank Swap Lines Work? 


When liquidity tightens in one currency it becomes difficult for banks outside that currency area to fund assets that are tied to the currency as they have no direct access to the central bank that issues the currency. If a swap line is established between the two central banks, the domestic central bank is then able to provide domestic banks with the required foreign currency without dipping into its foreign reserves. 

#3 What is the impact on the future path of monetary policy? 

Target in Sight 

The ECB remains firm on ensuring inflation returns to target, and as a result, the ECB raised rates by 50 basis points (bps) at its latest (March) meeting, despite the worries surrounding financial sector volatility. 

Previously, the ECB has underestimated inflation and remains concerned it will do so in the near-term. The ECB expects inflation to average 5.3% in 2023, 2.9% in 2024, and 2.1% in 2025 according to its latest projections.  

There are a few areas of concern for the ECB that could determine the future path of interest rates: the end of government subsidies (which include price caps on household energy bills, exempting vulnerable households from higher energy prices, or one-off energy price allowance) and the potential de-anchoring of inflation expectations. Let us look at each of these concerns individually: 

  • Government subsidies ending, causing a spike in energy prices: according to the ECB, the end of government subsidies are likely to add 0.7 percentage points (pp) to inflation and 0.4 pp in 2024 and 2025, respectively. As Europe nears the end of the peak heating season, the region has a sufficient volume of gas still in storage which is likely to lead to further downward pressure on energy futures prices. 
  • Potential de-anchoring of inflation expectations: actual inflation in part is dependent on inflation expectations. Inflation expectations are tracked through surveys, forecasts, and inflation-related financial instruments. The anchoring of inflation expectations is necessary to prevent inflation feeding into wage and price formation (in what is often referred to as a spiral as one begets the other). Median expectations for inflation over the next 12 months (very) modestly declined to 4.9% from 5.0%. While this is fairly stable, it is noteworthy that for Europe, this represents an elevated level of inflation compared to prior cycles (historically the average for inflation expectations over the next 12 months is 1.6%). 

Central banks are remaining firm, making sure the inflation target remains in sight. With the recent developments in inflation, the interest rate outlook is likely to be altered, with further rate hikes beyond March now an increasing possibility. 

#4 What Is the Impact on European Commercial Real Estate? 

The higher cost of borrowing has already impacted commercial real estate, causing a correction in capital values across all subsectors; relative to Q1 2022, Q4 2022 yields had moved out by 60 bps, on average, across offices; 97 bps across industrial; and 28 bps in retail. Note that the upward shift in yields has been driven by higher sovereign rates versus a substantial widening in risk premia. For real estate owners, rising interest rates and declining property values further challenges debt refinancing prospects, but these concerns have been known for a while and are only marginally impacted by the latest events (largely in the form of increased uncertainty, risk aversion on part of investors, and lower lending liquidity as lenders take pause to evaluate the conditions). In other words, on the margin, the latest events have not had a material impact on CRE financing conditions other than to extend and exacerbate the current “pause” among lenders. 


Although it is still too early to assess what impact this will have on real estate investment, it is adding to the level of uncertainty, giving some investors more reasons to pause and delay their return to the market. This is particularly true for conservative debt lenders, including life insurance companies and banks. In the interim, there may be an opportunity for non-traditional debt lenders like private funds and equity investors to ramp up debt offerings as others step to the sidelines. It is worth noting, however, the non-traditional lending markets may come under more scrutiny as a result of the recent event (as potential debt investors grow concerned over the sector’s less-regulated environment). Whilst this will not offset the full loss of liquidity, it may provide opportunities for select investors in an otherwise challenging climate. Motivated buyers may actually see current events as being the start of a buying window as pockets of distress emerge. 

All in all, for commercial real estate, recent events will reinforce the polarisation of the market we have seen previously, between those waiting for greater certainty and revised pricing before acting and those ready to buy when opportunities emerge. The former will be more restrained, the latter perhaps invigorated that the cycle is turning for them. 

#5 What to Watch for… 

  1. Crisis of confidence: Confidence is key to financial and banking market stability, liquidity and functioning. To avert a crisis, confidence must be maintained and restored where it’s lacking in the banking sector: no bank can withstand a loss of confidence and a run on deposits. The banking sector’s business model is built on confidence. Previously, we have seen isolated incidents cause ripples across the sector and beyond, which is one reason why central banks feel the need to intervene to help restore confidence when it’s lost. Fortunately, in the case of Credit Suisse, issues were well-known and idiosyncratic. The U.S. banking system has undergone a more significant episode of confidence loss but is similarly being restored via aggressive policy actions

  2. Credit conditions: One key aspect to watch will be the extent to which these events cause banks to reduce credit availability. If lending conditions are tightened further, commercial real estate values could witness further falls with the correction largely concentrated in the lower-quality segment of the market. Tighter lending conditions are also likely to worsen the shortfall in prime assets, which is already being witnessed across a number of European markets and sectors. 

  3. Impacts of monetary policy are often lagged: The impact of higher rates on the financial sector also comes through with a lag. We published our latest European Macro Outlook which outlined that it takes five quarters for the impact of interest rate hikes to come through into the real economy. As this has been the most aggressive monetary tightening cycle in four decades, it should not come as a surprise if some cracks begin to appear. Thus, as we witness challenges in the financial markets adjusting to a higher interest rate environment, it should be unsurprising that a few banks or firms experience difficulties.

  4. Banks overly concerned about a negative market reaction, overly reliant on central banks: The pandemic was the first major test of the financial system since regulatory reforms were introduced following the GFC. The pandemic also highlighted a few things within the financial sector. According to the Financial Stability Board, the majority of banks did not need to use their capital and liquidity buffers to meet loan demand as they were able to maintain strong capital positions during the pandemic, which were further reinforced by public measures (e.g., fiscal policy that supported borrowers directly and lenders indirectly/directly). Although this is not necessarily a bad thing, as the situation to use them did not arise, there was some evidence to suggest that banks were hesitant to use their buffers even when needed.  

The Liquidity Coverage Ratio (LCR) was introduced following the GFC, which requires banks to hold a sufficient buffer of high-quality liquid assets (HQLAs) so that they are able to meet their obligations during times of severe stress. By introducing the LCR, the aim is to reduce the risk of spillovers to other financial institutions and to the wider economy. Banks actively maintain an average LCR level well above 100%—that is, a ratio of HQLAs that exceeds cash outflows (over a 30-day period). The banks’ reluctance to use their liquid assets during times of stress can be down to two factors: i) to avoid declines in their LCR, particularly below 100%, as domestic regulations may require banks to put in place triggers to activate a recovery plan to restore LCR above 100% again; ii) concerns about how the market, and in particular, credit rating agencies may perceive the decline in LCRs. Although Basel Pillar 3 only requires banks to disclose LCR as averages, some large banks voluntarily disclose LCR as a point-in-time. The reluctance of banks to absorb part of the stress, through the use of their HQLAs, means that central banks, more often than not, have to intervene, suggesting that banks could now be overly reliant on central banks stepping in when required. Banks should be able to utilise liquid assets in times of stress, without the unintended consequences of negative market reaction. If banks become overly reliant on central banks, this may encourage banks to underestimate the risk of losses when making decisions as they simply do not have to bear the consequences. 

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