Regulators are asking American banks to stop glossing over their vulnerability to the crisis in Europe.
The Securities and Exchange Commission issued guidance on Friday pressuring U.S. banks to provide detailed information about their exposure to European debt so that investors could make more informed decisions. Since uncertainty about U.S. banks' exposure to Europe has led to lower stock prices and higher borrowing costs for banks, a collective move to come clean could help dispel investor fear and promote economic growth. More broadly, a clearer picture of banks' exposure could help prevent a repeat the 2008 credit crunch and financial collapse.
"Disclosures...have been inconsistent in both substance and presentation," the SEC wrote. "We believe this inconsistency may lead to disclosures that lack transparency and comparability for investors."
The SEC requested that U.S. financial institutions disclose their full exposure to government debt, bank debt, and corporate debt for each European country; how they have hedged that exposure; and an explanation of what would happen if their losses were not covered by insurance. They have asked for banks to reveal what would happen in the event of credit rating downgrades, as well as a full accounting of their derivatives and credit default swaps related to Europe, including the identities of counterparties, so that investors could have a holistic view of what would happen in case of a financial crisis.
Bank stocks plunged in value last year to a large extent because of investors' uncertainty about exposure to Europe. Financial stocks plunged 18.4 percent in 2011, performing the worst out of the 10 industries tracked in the S&P 500, according to Bloomberg News. Bank of America's stock value plummeted 58 percent, Goldman Sachs fell 46 percent, JPMorgan Chase fell 22 percent, and Citigroup and Morgan Stanley fell 44 percent.
Interbank borrowing costs also have spiked. The interest rate on three-month interbank loans has more than doubled since mid-July, according to Bloomberg.
It has become nearly impossible for investors to compare the vulnerability of different financial institutions to the crisis in Europe, since their disclosures are so inconsistent, according to analysts interviewed by The Financial Times. Some investors are concerned that European banks that have written credit default swaps on European debt could fail in the event of a financial crisis and be unable to pay insurance to U.S. banks holding the credit default swaps, according to the FT. The SEC wants investors to be able to judge banks' protection for themselves.
Goldman Sachs and JPMorgan Chase are among the major banks that are keeping investors in the dark about their exposure to European debt, according to Bloomberg News. Though they say they have sold protection on more than $5 trillion in debt globally, they have not disclosed how much of that debt is held by Greece, Italy, Spain, Ireland, or Portugal: the five European countries currently mired in debt crises.
U.S. banks held $1.48 trillion in exposure to all of Europe as of the end of June -- which includes government debt, insurance on that debt, and loans to European businesses -- according to the Bank for International Settlements.
But as long as banks keep details on their exposure to Europe hidden, investors could flee.
"If there is another credit crunch, it will not really matter that much how much you actually own sovereign debt," Gabriel Palma, economics professor at the University of Cambridge, told The Huffington Post in December. "Because nobody trusts each other, because they hide their risks so well and so deep...no bank in the world will get any money from anybody else."