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US banks are watching a film that their European peers will feel they have already seen: Basel III, the Endgame.
An updated US bank capital regime, announced by watchdogs in July last year, has its origins in the work of the Basel Committee on Banking Supervision following the financial crisis. US banks worry this will weigh them down with more capital, hurting their returns. In doing so, that could narrow their long-standing lead over beleaguered European peers.
EU and UK regulators are well advanced in implementing the Basel III principles, which require added capital buffers for more volatile business units. Most banks have prepared for adjustments, which primarily concern credit risks. European bank bosses have groaned but generally have followed the lead of the European Central Bank or Bank of England.
US banks just see a horror show. Prominent bankers, including JPMorgan Chase’s Jamie Dimon, complain that the US proposals are more punitive than in other jurisdictions. Very conservative weighting recommendations will push up risk-weighted assets. For corporate and investment bank divisions alone, this means a 35 per cent jump in risk-weighted assets, more than double that proportion for European banks, according to a Morgan Stanley/Oliver Wyman report.
More risk-weighted assets require more capital as loss buffers. Even strong banks such as JPMorgan, generating excess (common equity tier one) capital of half a point quarterly, would have less for shareholder payouts via buybacks. In turn, more capital can depress the crucial return on equity measure.
For years, US banks outstripped their European counterparts here. US bank returns have averaged about 10 per cent since 2019, about 4 percentage points ahead of Europe, according to MSCI and Bloomberg data. That is one reason global investors steer clear of Europe’s banks, thinks Joseph Dickerson at Jefferies.
Higher interest rates, and subsequent higher income, in the past two years have enabled Europe to close the ROE gap in the past year. Should the US Basel proposals be fully implemented, US bank returns on equity could potentially fall below that of the counterparts. A 37 per cent jump in overall risk-weighted assets for US banks, in the harshest scenario, would depress US bank returns by up to 6 percentage points, say Morgan Stanley/Oliver Wyman. A lower return on equity usually means a lower price to book valuation, a key metric to judge financial institutions.
US regulators, not unreasonably, point to the mess following the Silicon Valley Bank failure last year as proof the system needs reinforcing. One suggested that banks should look at their dividends and buybacks, before complaining.
If the watchdogs win out — a big if given America’s powerful bank lobby — US banks would look expensive, confirming an obvious relative value trade into Europe. Already the shares of some, such as UniCredit, have left world banks in their trails.
Most, however, persistently trade 40 to 50 per cent of their book values. No wonder US bank chiefs do not like the story they are watching.
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