After all the talk about Deutsche Bank having to pull back from Wall Street simply so that it can pay its DOJ fine (it's not pulling back incidentally, or at least its investment banking division isn't), you might be feeling a bit worried about the stability of your job at a European investment bank in North America.
A report out this week from Bernstein Research suggests these fears are entirely rational. European banks on Wall Street are stuck between a rock and a hard place and their predicament is likely to become more apparent over the next 18 months.
Bernstein says it all boils down to the introduction of U.S. Intermediate Holding Companies (IHCs) in July this year. Since then, the U.S. branches and subsidiaries of global banks that have more than $50bn in assets have been ring-fenced within the U.S. They are now treated as U.S. institutions when it comes to stress tests and capital planning.
Moreover, the application of U.S. rules to European banks is likely to tighten. Bernstein points to a recent speech from Daniel Tarullo of the Federal Reserve in which he said he plans to revisit whether the "global market shock and counterparty default component" of U.S. banks' capital assessments should be applied to European banks' U.S. arms too.
This could be a problem, because European banks also have capital issues at group level. At the group (ie. global) level, Bernstein says European broker dealers have capital gaps of more than $10bn each compared to their U.S. peers. If Barclays as a group were domiciled in the U.S., for example, Bernstein calculates that it would probably need another £15-20bn of tangible equity to hit peer levels. In the same situation, Bernstein says Credit Suisse would probably need another CHF12-15bn.
European banks are undercapitalized globally compared to their U.S. peers:
How under-capitalized are the European banks' new U.S. subsidiaries? After looking at their capital levels, Bernstein thinks they have gaps ranging from $1.7bn (BNP Paribas) to $9bn (Barclays). Deutsche, interestingly, doesn't have a gap - but this is pre-litigatin charges...
Capital gaps at European banks' U.S. holding companies:
The good news is that European banks can't simply pull back from the U.S. and lick their capital wounds. Doing so would damage their entire investment banking franchises, says Bernstein. The bad news, is that they'll probably have to keep deleveraging and reducing the value of their U.S. balance sheets. However, they've done this a lot already and are losing market share because of it...
European banks have already been deleveraging in the U.S., witness Barclays and Credit Suisse:
While all this is going on, European investment banks on Wall Street need to hope nothing nasty happens. European banks' U.S. operations will be subject to U.S. stress tests in 2018, and U.S. stress tests tend to be a lot stricter in their treatment of risky level three assets. Unfortunately, European banks have a lot of these assets on their balance sheets compared to U.S. banks. If markets become more stressed, U.S. regulators will insist the Europeans hold even more capital to cover the danger of these assets falling in value.
European banks have a lot of risky assets on their balance sheets:
So far, European banks have simply formed their U.S. intermediate holding companies. The pressure is about to get ratched up next year. In January 2017, the IHC capital plans must be privately submitted to the Federal Reserve, at which point Bernstein says European banks will probably have their first discussions on capital with the U.S. regulator. The IHCs will need to meet U.S. leverage requirements by January 2018 and will have results to their U.S. stress tests disclosed by mid-2018.
So, the Europeans on Wall Street have around 18 months to put their houses in order. Until they've done so, their U.S. balance sheet-heavy businesses look a little exposed.