European banking regulators step up guard amid market rout

Frankfurt — Central bankers and supervisors in the eurozone, Britain and Switzerland have increased their monitoring of banks and markets amid a trade war that has routed markets but have found no reason for alarm yet.

Stocks around the world have fallen sharply since US President Donald Trump unveiled sweeping global tariffs, stoking fears of a recession in the world’s largest economy and a potentially destabilising market crash.

The European Central Bank (ECB), which sets interest rates for the eurozone and oversees its biggest banks, has heightened its level of scrutiny because market sell-offs can result in damage to the real economy if they last long enough, four sources said.

ECB supervisors have been calling banks on their watch more frequently than usual to check on deposits and other forms of funding. The feedback so far has been reassuring, the sources said, a point also made by Bank of Spain supervisor Mercedes Olano.

ECB central bankers and market regulators in Switzerland and France were also reassured to see that market liquidity had not dried up, meaning sellers could easily find buyers, even for large positions.

The market operates in very large volumes, allowing all investors to trade according to their needs, French market regulator AMF said in an emailed statement.

A source said that the Bank of England was also monitoring the markets for any liquidity strains.

ECB policymakers, unlike their peers elsewhere in Europe, have to contend with a bloc of 20 different economies and have zeroed in on government bond spreads, or the premium that weaker borrowers pay over the eurozone’s benchmark, Germany.

Seen as a measure of investor confidence in the eurozone, spreads have widened slightly but remained under control. Italy’s 10-year bonds, for example, were yielding just 122 basis points more than their German counterparts.

This is a far cry from the 250 basis points spread investors were demanding to own Italian debt at the height of the Covid pandemic in 2020 and when the ECB began raising rates in 2022.

Short-term over-reaction

Speaking in Spain on Tuesday, ECB vice-president Luis de Guindos said markets “always over-react in the short term” and had to find a new equilibrium in a new, more fragmented world where growth is likely to be lower and inflation higher.

The euro was also rising against the dollar as the world reassessed the US’s economic prospects and diversified away from the US currency, de Guindos and others noted.

While the situation in Europe remained under control, officials in the eurozone and Switzerland are still worried about trouble spilling over from Wall Street, in particular from funds acting as lenders.

“It is very important that we primarily follow developments in the so-called nonbank financial institution sector, which includes hedge funds, private equity funds, credit funds and so on,” Switzerland’s top market regulator Stefan Walter said on Tuesday.

ECB sources also flagged the risk that damage at these so-called shadow banks could ricochet on the traditional banking system.

Another ECB source indicated a spike in volatility — as evidenced by the widely monitored VIX index that measures option prices on US stocks — as an indication that financing conditions were worsening on capital markets.

ECB policymakers are set to compare notes at a meeting of the EU’s financial policymakers in Warsaw later this week. But sources said an in-depth discussion would only happen at a Governing Council meeting next week, when the ECB is expected to cut rates.

An ECB spokesperson declined to comment.

Reuters