Important Differences Between European Banks and SVB

We do not believe investors should view the collapse of U.S.-based Silicon Valley Bank as a read-through of the health of European banks’ balance sheets. Nevertheless, banks remain highly reliant on the confidence of depositors and other funders. It would be foolish to say there is no contagion risk for European banks, especially if other global banks run into trouble. The current uncertainty could also push up the cost of funding and increase the rate at which European banks pass on higher interest rates to depositors. But we believe it is vital for investors to take note of the contrasts between European banks’ and SVB’s balance sheets.

SVB’s asset liability management was poor. SVB actively extended the duration of its assets to capture higher rates, which led to a substantial duration mismatch. Duration mismatches at European banks are nowhere near as pronounced, and European banks actively manage mismatches using hedges and matching strategies. Ironically, one of the main drivers for European banks to own bonds in the first place is to match the duration of fixed-term deposits.

The exposure of European banks to bonds is much smaller than that of SVB. We calculate that bonds held in the available-for-sale and held-to-maturity buckets made up 55% of SVB’s assets. The equivalent for the average European bank we cover is only 8%. Adding insult to injury, U.S. regulations exempted SVB from the requirement to deduct unrealised losses on its available-for-sale bond portfolio from regulatory capital. All European banks we cover must deduct unrealised AFS losses from common equity Tier 1 ratio capital. Therefore, European banks’ unrealised losses are limited to the 4% of assets accounted for as held-to-maturity bonds.