By Huw Jones
LONDON (Reuters) - Banks in the European Union must be "conservative" with dividends and other payouts after recent turmoil in the sector, and focus on keeping their cash buffers topped up, the European Union's banking watchdog has told Reuters.
Jose Manuel Campa, chair of the European Banking Authority, said banks had strong capital and liquidity buffers, with a key measure of profitability now at a decade high.
But it was unclear how rapidly rising interest rates will ultimately affect the economy and customers of banks, he said.
"The impact will come for sure," Campa told Reuters. "That impact we will continue to monitor."
Paris-based EBA ensures national banking supervisors apply EU banking rules, and coordinates regular health checks of banks across the bloc, with the results of the latest stress test due in the summer.
Banking shares tumbled last month after collapses of Silicon Valley Bank and other U.S. lenders, and the forced takeover of ailing Credit Suisse by UBS.
These events should prompt EU lenders to take a closer look at their capital planning, particularly dividends and other distributions, to bolster market and customer confidence, Campa said.
"They should look at conservative scenarios," he said.
While banks now have very strong liquidity positions, they will have to pay back loans from central banks, he said. "We need to make sure that they remain with sufficient so-called high quality liquid assets," said Campa, a former senior official at Spain's Santander (BME:SAN) bank.
Banks should pass on rises in interest rates to depositors given the ease with which they move their money to another bank online, which caused problems at Silicon Valley Bank, Campa said.
"The banks will have to be very prudent in how they price, and be active in how they keep their depositors," Campa said.
There has been some worry about "unrealised" losses in bond portfolios of banks, also a factor in the collapse of Silicon Valley Bank.
"American banks have about 20% of their balance sheet in fixed income portfolios. EU banks only have 11.3%. We are asking supervisors to monitor," Campa said.
CDS MARKET A "CONCERN"
The market for credit default swaps (CDS) is now an "area of concern" for regulators after sharp volatility in CDS for Deutsche Bank (ETR:DBKGn), Campa said.
"We are really trying to understand from that episode what are the interlinkages of those markets. I think all authorities are assessing this," Campa said.
EU securities watchdog ESMA is also looking at the CDS markets, and the derivatives industry says regulators already have data on the market.
"We need to understand how these markets are working, how liquid they are, and how easy it is for small quantities of positions to really move prices," Campa said.
There is no evidence, however, that recent banking turmoil shows the need for a rethink in banking rules, Campa said.
"The global consensus is that we should implement the rules that were approved after the global financial crisis," Campa said.
"What we have learned so far in the last two weeks is that the rules have helped rather than hurt."
The EU is due to update its framework for closing failing big banks to include medium sized lenders.
"I think that's good. I encourage them to go in that direction," Campa said.
Critics say Credit Suisse's takeover showed that post-financial crisis rules to end "too big to fail" banks and avoid public help have not worked.
"I think the Credit Suisse event shows that resolving a large systemic bank is always going to be difficult. I don't think we can ever be 100% comfortable. We have made a lot of progress, but it was always going to be difficult."