StockBeat: Bank Stocks Flying as Tail Risks Recede

By Geoffrey Smith

Investing.com -- Europe’s battered bank stocks are flying again for a second day as the flood of central bank liquidity lifts all boats, while regulators’ reassurances on how to account for the inevitable sharp rise in distressed loans is also lending support.

By 6 AM ET (1000 GMT), the Stoxx 600 Banks index was up 5.2%, adding to Tuesday’s gain of nearly 10%. Ireland's AIB Group (IR:AIBG) shares were up 16.3% while Societe Generale (PA:SOGN) shares were up 10.3% and Deutsche Bank (DE:DBKGn) stock was up 7.1%.

The benchmark STOXX 600 index was up 3.6% at 312.80.

Banks now have some 823 billion euro ($890 billion) worth of loans outstanding through the European Central Bank’s refinancing operations, more than at any time since 2013, after a spate of open market operations that have shown how much they need central banks’ backstops right now.

Among that increase is around $116 billion offered through a swap facility with the Federal Reserve. Banks’ demand for seven-day dollars fell sharply at this week’s auction to only $4.1 billion at an operation on Tuesday.

“We see this as an indication that whilst stress in US$ liquidity remains elevated, the ECB’s backstops have successfully reduced them,” Goldman Sachs (NYSE:GS) analysts led by Jernej Omahen said in a note to clients on Tuesday.

At Wednesday’s auction of seven-day funds, demand fell from $36.3 billion a week earlier to $17.3 billion, suggesting a further easing of tensions.

There are other signs of tail risks being reduced, albeit gradually. The Eurogroup, which brings together eurozone finance ministers, inched toward activating the currency union’s 700 billion-euro bailout fund at their meeting on Tuesday.

While there’s some disappointment among periphery markets that there will be no joint debt issuance to underwrite what’s likely to be a massive widening of budget deficits, the key point is that recourse to the European Stability Mechanism further enhances the guarantee of ECB support through outright bond purchases (although last week’s new 750 billion QE program should already cover most eventualities).

Elsewhere, the European Banking Authority on Wednesday formally gave its blessing to what amounts to the suspension of accounting rules that force banks to book provisions early against loans that they expect to turn sour. The IFRS 9 rule was adopted after the last crisis to stop banks pretending that bad loans were still good, but risked making a bad situation worse if narrowly applied in the current downturn, which is of a very different nature.

“There is a broad understanding that the operational capability of banks in making in-depth assessments may be more limited under the current circumstances, hence short-term flexibility in operational requirements is warranted,” the European Banking Authority said in a statement, which gave clear precedence to meeting the immediate needs of the economy for credit.

“Given the nature of the present shock which may also have medium and long term implications the flexibility embedded in the accounting and regulatory frameworks is to be fully used by institutions to help maintain soundness through the crisis and provide critical functions to the economy,” it added.

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