BNP Paribas and the EUR

The news that French bank BNP Paribas would be fined nearly $9 billon by US authorities and banned from clearing certain dollar-based transactions for a year, caused some concern about what it could all mean for the EUR. Politicians have been involved, and even the French finance minister said that the ban on BNP Paribas’s trading activity is a sign that dollar hegemony should be broken up. We decided to take a look at the potential implications for the FX market based on the short, medium and long term, as you can see below.

Short term: EUR impact

The fine, at approx. EUR 6.6bn, is lower than some people feared. While it is no small chunk of change, it looks like a manageable sum. Although we don’t know how the fine will be paid – in one lump sum, in instalments etc. – considering average turnover in the FX market is $5 trillion per day; this fine should have no noticeable impact on the EURUSD exchange rate. Added to this, BNP Paribas has been keeping money aside for some time as it knew it was under investigation and a hefty fine was inevitable. Hence, confirmation of the fine did not spook the markets, and BNP Paribas’s share price on Tuesday was only a little weaker than the overall market. EURUSD barely blinked, and at the time of writing it was above 1.3600.

Medium-term: Bank stress tests

Could the US fines have an impact on the ECB’s bank stress tests, the results of which are set to be published later this year? Ahead of news about the size of this fine, this was a genuine concern; however, since BNP Paribas is estimated to have about half of the fine in reserve, it may not impact the bank’s capital ratio or hinder its stress test result.

Long term impact: The future of the dollar as a reserve currency

While the short and medium-term impact of this fine is fairly negligible, in the longer-term it could have more of an impact. We think it is worth flagging up four points:

1, Systemic risks: the US has taken a tough line with European banks, including BNP Paribas and Credit Suisse, when they have been caught ignoring US rules on trading with sanctioned entities. The biggest risk for Europe is that BNP Paribas does not draw a line in the sand, and is only the tip of the iceberg. US authorities used 8-years of trading activity as evidence of BNP Paribas’s violation, it is unlikely that BNP Paribas had the “sanctioned” market all to itself, thus other European banks could become embroiled in the scandal and face large fines. If the markets perceive this as a witch hunt then we could see selling pressure on the EUR and European stock markets, particularly the financial sector. If future investigations correspond with weak bank stress test results that could be the most toxic situation for the EUR, in our view.

2, Reputational damage: The big problem for the ECB right now is how to get European banks to lend to Main Street. One of the reasons why the ECB has not embarked on QE is because the bulk of Eurozone financing is through bank loans, not bond markets, thus QE may only have a limited effect. After announcing a new package of measures to boost bank lending last month, including plentiful TLTRO loans, the last thing that the bank wants is for reputational damage to get in the way of the banks’ lending businesses. Reputational damage should be a key concern for BNP Paribas’s top brass right now, a trickle of high profile clients ditching the bank could turn into a torrent that could destroy its business over the long term and a knock-on effect could be a weaker EUR.

3, Sovereign risks: The toxic link between domestic financial institutions and the sovereign state has brought torment to some European countries in the last few years. If the long-term risks materialise and banks like BNP Paribas see their business and profits take a long-term hit, will governments have to bail them out? The ECB’s stress tests are set to reveal any potential capital vulnerabilities in Europe’s banking sector. Any capital gaps found are expected to be filled by the ESM bailout fund, however, if these potential capital gaps are a consequence of US legal action, will the ECB et al agree to allow banks to fund any shortfalls with bail out money, or will it fall on the sovereigns, straining their creditworthiness just as the Eurozone was getting back on track? With peripheral bond spreads so tight, this is a key risk right now, and if it was to become a reality it could have a severe negative impact on the single currency.

4, Dollar as reserve currency: The French finance minister sounded so angry at the trading ban slapped on BNP Paribas earlier this week that he suggested it should be used as an excuse to erode the dollar’s reserve currency status and bring the EUR to the forefront. The dollar still accounts for more than 60% of all trade, the EUR less than half of that, thus even if there is a push to replace the dollar with the EUR as the world’s reserve currency it could take many years, if not decades, for a shift of this magnitude to occur. Apart from nations sanctioned by the US, it is hard to see who else would get behind a campaign to install the EUR as the world’s reserve currency on the back of US regulation mishaps by European banks, thus we don’t think this is a realistic scenario for the EUR at this stage.

As you can see, we think that the impact of BNP Paribas’s fine is likely to be limited and should not have any impact on the EUR in the short term. The biggest longer term risk is reputational damage. If that happens, and only time will tell if it does, then banks could come under pressure, forcing the ECB to take more drastic action such as QE to calm the markets and protect the sovereigns from banking liabilities, which could weigh heavily on the EUR. Until then, the Fed, not European banks, could be the biggest impact on EURUSD.