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Bank capital: more than meets the eye


The coronavirus crisis is a further reminder that fundamentals are not the only thing that matters when investing in bank capital.

Many European banks have used the first half of 2020 to build up big reserves for credit losses. 

They are rightly worried that the economic fallout from Covid-19 could lead to a wave of defaults through their loan books. 

None of this has exactly flattered their income statements, with profit margins having collapsed from an already low point for many lenders this year. 

But there has been absolutely no sign of a crisis when it comes to bank capital levels. 

In fact, Europe’s largest lenders added an average of about 55bp to their common equity tier one (CET1) ratios in the three months between April and July. 

Many of them have stronger capital positions than at the beginning of the year. 

It would be wrong to conclude that pandemics are good for bank solvency, however. 

What market participants are seeing is a powerful example of why bank capital investors have to be so in tune with what rule makers are thinking. 

CET1 levels improved in the second quarter because regulators were happy to extend more support to the industry. 

Institutions have been able to offset the harmful impact of IFRS 9 accounting rules, for example, and they have used more favourable capital treatment for their SME exposures. 

Spend enough time listening to regulators and you’ll soon hear about how banks are no longer a part of the problem. 

If there’s one thing the Covid-19 crisis is proving, it is that these sorts of perceptions can be just as important as reality.