Still Not a Level Playing Field; Regulatory Differences Drive Relative Returns
A wide gap in average risk weights …
European investment banks (IBs) report similar risk-based leverage (CT1) to those in the US, but substantially higher “simple” leverage (TATE). This is a function of differences in average risk weights, which in 3Q2010 stood at 27% for European IBs versus 54% in the US, on our estimates. This disparity can be explained by multiple factors, with genuine business mix differentiation being important. Pure methodological differences are also meaningful, in particular for market RWA.
… set to continue under Basel III
Under Basel III, the gap in average risk weights does not close, on our estimates, allowing the leverage disparity to continue. Swiss IBs are an exception, as (substantially) higher minimum capital ratios (as per new Swiss regulation) compensate for lower risk weights, thus closing their TATE gap with US peers.
In our view, global comparability of risk-based leverage cannot be achieved without ensuring a consistent and transparent approach to RWAs.
European IBs’ competitive position improves
The end game of the current regulatory set-up is an improved competitive position for non-Swiss European IBs (e.g. Deutsche Bank, BNP Paribas), in our view. Comparatively higher leverage should allow for a pricing advantage and consequently an increase in their global market share.
For Credit Suisse/UBS, we expect steady-state returns to de-rate, as Swiss regulation drives a sharp increase in capital per unit of assets; CoCos can be a partial mitigant. All in, we struggle to see Swiss banks exceeding mid-teen ROTE under the new regulatory regime (exceeded 30% pre-crisis). We find that the historically high return differential between Swiss IBs and Deutsche Bank closes when targeted capital structure is applied.
CS down to Neutral; BNP remains CL Buy
We downgrade Credit Suisse from Buy to Neutral following a revision of our valuation model and steady-state returns under the new regulatory proposal; our preferred European bank with exposure to capital markets is BNP Paribas, which is on our Conviction Buy List. In our view, global comparability of risk-based leverage cannot be achieved without ensuring a consistent and transparent approach to RWAs.