The third quarter ended positively for our strategy, with a return of +21% for the year to date. The MSCI World index has returned +11% over the same time period.
The weight of EU banks in the portfolio was slightly reduced in the last week, and I now expect to keep their weight contained for the next few months.
The reason is that the governor of Austria’s central bank, Robert Holzmann, suggested in a newspaper interview that he would prefer it if the European Central Bank increased the minimum reserve requirement on euro area banks from 1% to 10%.
Why is this important? Euro area banks do not earn any interest income on minimum reserves – it is dead money for them. The higher the required minimum reserves, the lower the profits of the banks.
A one percentage point increase in the minimum reserve requirement could hit bank profits by 2-3%.
So, if the minimum reserve requirement was indeed raised from 1% to 10%, bank profits could fall 20% or more. The market believes that Holzmann is an outlier on the ECB’s Governing Council and that his proposals won’t be implemented.
The market is instead betting on a much smaller increase in the minimum reserve requirement to 2-3%, which would lead to a contained 5% drop in bank profits.
However, as long as the possibility of a 10% reserve requirement exists, holding EU banks will be risky.
NN Group, Caixabank and Commerzbank were sold; Itau Unibanco, Beazley and ABN Amro bought.