People walk in London's City financial districtLefteris Pitarakis/The Associated Press
After weeks of stress tests and just plain stress over the potential impact of global banking reforms, Europe's hard-hit banks are breathing a sigh of relief.
Switzerland's UBS AG France's Société Générale and Crédit Agricole, and Alpha Bank AE of financially embattled Greece led European banks to their biggest market gains since May, as investors reacted positively to strong earnings reports and a watered-down version of forthcoming reforms on bank capital.
The resurgence comes after weeks of hand-wringing over European bank stress tests proved to be unnecessary when all but a few of the financial institutions passed the minimum requirements for capital.
But the key reason for the rally was the realization that Europe's largest financial institutions will be given more time by regulators to fix their balance sheets, which have been battered by recession and the continent's sovereign debt crisis.
A return to health for the banking sector in Europe and the United States is considered by many economists to be a prerequisite for sustained growth in the global economy.
As central bankers and regulators move toward new rules designed to stabilize the global banking system, several of the strictest measures being introduced by the Basel Committee on Banking Supervision have been watered down.
Most banks will not have to immediately raise large amounts of new capital, giving shareholders hope that any surplus will be used for share buybacks and dividend hikes after the new rules are adopted.
"We see confirmation of the changes as a positive catalyst for the sector, especially following on from the European bank stress tests," John Peace of Nomura Asset Management Co. said in a research note to clients on Tuesday.
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A requirement that the world's banks keep at least $3 of capital on hand for every $100 they lend will be put off until 2018.
This will give many European banks time to work up to the target if necessary, instead of having to comply in 2013. While the matter is less of a concern for Canada's banks, which are comfortably above that threshold, it is a relief for some of the more-constrained European banks.
In another concession, banks will be allowed to count a portion of their investments in other financial institutions and other measures such as tax gains as tier-one capital, the most liquid form of capital they keep on hand.
The changes come just days after the European stress tests determined lenders in Europe need to raise about $4.5-billion (U.S.) of capital to meet minimum requirements to avoid another financial crisis, which was about a tenth of what most estimates figured Europe's banks would have to come up with.
Investors drove up shares of Greece's Alpha Bank AE by 11.3 per cent Tuesday, while Société Générale and Crédit Agricole of France rose more than 10 per cent each. Swiss banking giant UBS issued second-quarter results on Tuesday that beat expectations and gained 11.2 per cent.
Germany signalled it won't back the banking reforms until it sees more detail on the capital targets set by the Basel Committee. However, officials in Berlin told reporters the concerns centred mostly on the country's co-op banks, which lend to small and medium-sized businesses, but don't have any real equity on their books such as retained earnings. The Germans want that nuance recognized.
Canadian banks also saw a lift on Tuesday because of the changes. Analysts said the Basel Committee's move to allow investments in other financial institutions to count as tier-one capital could benefit several Canadian banks, including Toronto-Dominion Bank, which has a significant stake in TD Ameritrade, and Bank of Nova Scotia, which has a large stake in CI Financial. However, there is some question as to whether CI, an investment dealer, would qualify under Basel rules.
Initially, banks were not able to count such investments as tier-one capital, but would now be able to count them, along with future tax deductions on losses and mortgage servicing rights, provided those don't exceed a combined 15 per cent.
"With some of the more punitive elements included in the original document softened, we see the news as positive for the banks," CIBC analyst Robert Sedran said in a research note to clients. "Once rules are finalized … we look for banks to begin gradually returning excess capital."
With files from Dow Jones Newswires