Bank supervisor Claude Wampach: ‘The market is always right’

Claude Wampach, director banking supervision at the CSSF. Photo: CSSF.

Now that the initial dust on SVB’s collapse has settled, one of Europe’s top bank supervisors has a clear message for investors, bankers and financial market participants: banks in Luxembourg and elsewhere in Europe are safe and sound thanks to stringent supervision.

“If rates were to still increase, our banks would not sustain losses up to a level that would put their solvency into question,” said Claude Wampach, who serves as director of banking supervision at Luxembourg’s financial regulator CSSF, speaking to Investment Officer on 14 March.

As financial market volatility accelerated last week when depositors rapidly withdrew their funds from Silicon Valley Bank, financial supervisors from across the world were in close contact with each other and being kept abreast by the Federal Reserve. In Luxembourg, Wampach was closely watching events unfold. 

Wampach also is a board member of the EU’s Single Supervisory Mechanism, the SSM, which brings together the European Central Bank and national supervisors, and member of the Basel Committee on Banking Supervision, which sets common rules for the world’s banks.

His perspective is bolstered by the fact that the European Union, since the 2008 Great Financial Crisis, has built a comprehensive supervisory framework designed to ensure the financial health of banks is kept at a level to maintain financial stability. The SSM is one key pillar, along with a 60 billion euro European resolution fund paid for by banks.

Fresh questions for the Basel Committee

His other message: the SVB case raises new questions that need to be addressed by global bank regulators in Basel. “Let’s be clear. This also triggers questions to the Basel Committee itself, whether the liquidity coverage ratio in such cases works as expected.”

While the Fed understandably took a little while to keep its international counterparts abreast last week, Wampach said it was quick to catch up over the weekend once it became clear that SVB’s collapse also had international dimensions. The Silicon Valley bank owned a full subsidiary in the UK and ran and had an office in Frankfurt.

“The US obviously got a bit overwhelmed by the speed of the SVB case, which made it kind of difficult for them to reach out with the other authorities. Now, to be fair, there was rapid catch up with those jurisdictions that were most impacted because they had entities of the SVB, and that's in particular, the UK, but also Germany,” he said. “And of course, the reach-out was then to the wider SSM community and the ECB, where contacts were also pretty soon then established with the US authorities and also the UK counterparts.”

“Usually this goes then via calls, because that's the most efficient way to do things. It's a broader community. We know each other well,” he said, referring to the global supervisors. “We already know each other well from normal cases of business so that in times when things get a bit more stressful, we just know about who to call and to talk to.”

International market reaction unexpected

Not only investors were caught by surprise during the last week. Wampach frankly admitted that European supervisors like him were as well. In particular the widespread international market reaction came unexpectedly. 

“Obviously I was surprised because SVB was not on my radar. It is not one of the major US banks. Not a G-SIB,” he said, referring to the abbreviation used for major financial institutions, or Globally Systemically Important Banks. “SVB was a regional bank with a fairly limited international presence. Our focus and our exchange of knowledge is basically about the larger animals. But then, of course, if things happen with smaller institutions that might bring about some more systemic impact also for other jurisdictions, as was the case here, then the information flowed, and then basically also englobed these types of banks.”

Wampach said there are two ways to look at these problems. “One is we look at the issue with our kind of privileged inside information. That analytical work basically happens at the first stage. But then you have to realise that you are embedded within a broader system, which basically means you have to also look at what markets do because by the end of the day, that's what matters in the end.”

“We can as supervisors have a certain understanding of the situation, a certain assessment of the situation, but if the market has a different opinion or assessment of the situation, you know the market prevails,” he said. “So, we have to understand as supervisors how those market movements basically might impinge upon the system. You cannot ignore it. The market is always right in the sense that market dynamics will prevail.. And I was a bit surprised by the market reactions. That’s for sure.”

Managing interest rate risks

SVB’s collapse triggered widespread concerns on financial markets worldwide, catching both clients and investors off-guard. Shares of European banks declined 10 percent in five days, while bonds rose, with money market rates plunging amid talk that central banks now may have to pause hiking interest rates.

Managing interest rate risks is at the heart of the SVB case. The rapid rise in interest rates in the last six months caught it by surprise and forced it last week to recapitalize, a plan that did not succeed. That sequence of events was well known, especially to supervisors. What caught them by surprise however was the bank run that ensued last Thursday and Friday.

SVB “has sustained losses on its interest rate-sensitive asset positions. That was basically known to markets. What unfolded then was that very quick reaction from a large part of the depositor base that ran for the deposits,” he said. California authorities said depositors attempted to withdraw $42 billion within hours.

That bank run might possibly have been prevented had SVB been subject to more stringent supervisory rules. As an institution with less than $250 billion in assets, SVB however was no longer subject to the Dodd-Frank bank supervision rules. The Donald Trump presidency made such banks exempt from these rules back in 2018.

“That basically allowed these regional banks to have lower requirements on them. Now, to be fair, it's an open question whether that would have mattered,” Wampach said. “If you look at how the liquidity coverage requirement works, it would have basically asked the bank to hold liquid assets amounting to roughly  40% of its deposits. And then if you look at the bank, it was pretty liquid in the sense that it had massive holdings of what qualifies as high quality liquid assets under Basel standards.”

Testing impact of 200 bp rate hike

In Europe, both large and small banks are all subject to stringent scenario analysis that assesses interest rate risk on an annual basis, among other types of risk. Banks are required to assess how a 200 basis point swing in interest rates affects interest revenues and interest rate sensitive positions, including bond portfolios. Banks have been reporting this for the last 10 years, but the reporting is being read with more interest now that interest rates are rising.

“The uptick in inflation has made this one of the more prominent figures we’re looking at since the middle of last year,” Wampach said, adding that the outcome is “pretty fine”.

On aggregate Luxembourg banks basically satisfy their liquidity coverage requirements through cash holdings with the central bank. On the asset side, banks hold approximately 90 billion euro in bond portfolios. On the central bank side, there is about 300 billion in directly available cash. “So it's not as you had at SVB that you had a majority of assets that are long term, government securities. Here it's straight available cash. That means when interest rates move, you don't have a revaluation impact from these positions on capital or on profit and loss.”

The scenario analysis of the 200 bp interest rate impact shows Luxembourg banks are well placed. “I can tell you that all our banks, all without exception, remain solvent in such scenario,” he said. “So this gives us pretty comfort. If rates were to still increase, our banks would not sustain losses up to a level that would put their solvency into question.”

Next to this quantitative analysis European supervisors in recent months have begun to pay more attention to banks’ governance of interest rate risks. Although stress test calculations show little reason for concern, they feel some banks need to improve their monitoring of interest rates risks. Andrea Enria, the chair of the ECB supervisory board, has repeatedly addressed this in recent months.

Governance framework in focus

“We still see some weaknesses in the management of it, which does not mean that the bank is in such a weak situation that it would fail if interest rates go up, but it means that, in the broader governance and management framework built around the interest rate exposures, we spotted some weakness,” said Wampach.

“That distinction is very important. It does not mean that the bank is prone to solvency issues, but it simply means that, in terms of risk governance and risk management there is room for improvement” he said, adding that several banks in Europe have already been asked to put better rate risk management systems in place. 

Looking back at the changes in the European bank supervision introduced in recent years, Wampach is pleased to recognize the progress made. “I see a lot of progress that has been made with the advent of the SSM. This is about mutualizing resources, learning from each other. It’s a larger system. There are more resources.” 

“Your fellow supervisors also bring their perspective on things. The exchange is richer and there is more challenge. From that perspective the supervision has made progress, and of course it has made progress by bringing much more convergence. It was enacted in 2013 out of necessity, basically as a key part to overcome the European debt crisis. That was the aim, in a sense, and we succeeded at that. I see clear success in that.”

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