Risk of bank debt rising as regulators 'dreaming'

Ringfencing is on the agenda but regulators may be dreaming if they think it will stop contagion, warns Fitch Ratings.

Banks over the financial crisis have, by and large, not defaulted as governments bailed out their banks under the mantra of “too big to fail”. But fail they may, according to Fitch Ratings, who says that governments are getting tired of bailing our banks and their investors. 

“With bank default having been so low because of bank bail-outs – the 5 year default rate on banks is less than 1 %, considerations of potential recoveries in the event of a default have largely been irrelevant in practice,” Fitch managing director James Longsdon told the audience gathered for Fitch’s annual bank outlook conference. He added that unsecured debt holders could face large losses, especially if depositors are protected in the event of a default.

“You have to think of what type of creditor you are and also which part of the bank you want to be a creditor of,” said Longsdon. Traditionally, if a bank has had a problem in a subsidiary, the government has bailed out the head office. “In the regulators dreams they would like to ring fence parts of the bank and other parts get cut off. Therefore it will matter who you are doing business with and where, in other words counterparty risk is increasing.” But its not that simple says Longsdon.

“In practice its not that simple. To try to split banks into legal units and assume there isn’t contagion risk is extraordinarily complex; there is an inherent contagion.” Banks have got too hold a lot more capital and a lot more better quality capital. “When I look at the Swiss banks and the tightness, you do sort of wonder whether people stand there and think well don’t Swiss banks hold a lot of capital. Swiss banks are well above the norm.” He noted that whilst Basel II required 8 % capital, and Basel III 10.5%, Swiss Banks hold 20 % tier 1 capital.