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Here’s why European banks have had a strong start to the year

The City of London at sunset
Allan Baxter | Photolibrary | Getty Images
The City of London at sunset

After all the concern and consternation at the end of 2016, European banks have kicked off the year with a strong showing on the stock markets, as investors and analysts have become more bullish on the sector.

UBS is the latest broker to brighten its outlook, raising its price targets on BNP Paribas, Credit Agricole and SocGen.

The European banking index is trading 4 percent higher since the start of the week and major banks across the board such as Deutsche Bank and Credit Suisse have also made gains. But why are banks happy?

For a start, European banks have been in a rather cheery mood after global banking regulators postponed the approval of a reform package designed to insulate the banking sector from a relapse of the 2008 global financial crisis.


Central bank governors and regulators from more than 30 countries were expected to meet this weekend to approve a new reform package. One major part of these measures would have been reinforcing the level of capital lenders would have to set aside against loans and other assets. But the Basel Committee working on the reform said on Tuesday that more work needs to be done before the package could be submitted for approvals to the Group of Central Governors and Heads of Supervision (GHOS).

"This Basel postponement is very interesting," Gildas Surry, Senior Analyst at Axiom Alternative Investments told CNBC Thursday.

"People have been focusing on the quantum of capital requirements, capital regulation but essentially it comes down to the momentum and the time it takes for banks to adapt

"We have been moving from an environment where banks have been front-loading the new capital requirements up until 2016. Now, with the Basel III requirements postponed, there is more time to phase in so the banks will be given more time to implement those last batches of new capital."

The Basel III reforms are a comprehensive set of guidelines for banks to improve the regulation and risk management within the banking sector in order to avert a financial crisis. The guidelines require banks to hold a minimum Common Equity Tier 1 (CET1) ratio of 4.5 percent at all times. However, a new set of reforms that were due to be signed this weekend aimed to make it more challenging for banks to avoid these capital requirement levels.

While no time frame was provided for the next meeting, an official statement from the Bank of International Standards said the "Committee is expected to complete this work in the near future."


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Banks however are concerned that the new reforms could bring in an output-floor requirement, which limits banks to use their own model to calculate the riskiness of mortgages held on their balance sheets.

"The risk is an output floor that is binding for many banks in our universe (perhaps reduced given the delay). Unless we have fast clarity on whether Europe will apply it (fragmentation and balkanization if not), the market could think Europe is on board with Basel's output floors," Deutsche Bank said in an analysis note.

In November last year, the European Commission unveiled a new set of proposals aimed at banks operating in the European Union (EU) that could potentially add further pressure on balance sheets.

The key aspect of the proposed reforms is the implementation of a caveat that is designed to deal with the "too-big-to-fail" problem at an international level. Known as the total loss-absorbing capacity (TLAC), this part of the proposals is expected to tackle risks linked to globally and systemically important banks.

It would require banks to hold sufficient amounts of readily liquid capital in order to safeguard financial stability and public funds. The rules could affect big Wall Street banks, as well as other non-EU banks which have operations in the region.


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