European banks increase reliance on US dollar funding, EU regulator finds

European banks significantly increased their reliance on U.S. dollar funding and assets in 2024, raising concerns among regulators about potential funding shocks. The European Banking Authority (EBA) reported that dollar funding rose to 13.1% of total funding (from 12.4%) and dollar asset exposure climbed to 23% (from 19.3%), warning of a "meaningful currency mismatch" as one-third of EU banks' assets are in foreign currencies versus one-fifth of liabilities. This growing dollar dependency, particularly by subsidiaries and in wholesale funding, makes European banks vulnerable to a potential drying up of dollar financing, prompting calls from the EBA and IMF for enhanced monitoring and stress testing of liquidity risks.

Analysis

European banks significantly increased their reliance on U.S. dollar funding and assets in 2024, as reported by the European Banking Authority (EBA). Dollar funding rose to 13.1% of total funding from 12.4% a year prior, while total dollar-denominated asset exposure climbed to 23% from 19.3%. This growing dependency raises significant concerns among regulators regarding potential funding shocks, particularly given recent geopolitical and monetary policy uncertainties.

The EBA highlighted a "meaningful currency mismatch" within European banks' balance sheets, noting that one-third of EU banks' assets are denominated in foreign currencies compared to only one-fifth of their liabilities. This vulnerability is exacerbated by subsidiaries increasing their dollar reliance at a faster pace and by the fact that some EU banks exhibit a Net Stable Funding Ratio (NSFR) below the 100% minimum in foreign currencies, including the dollar.

Regulatory bodies, including the EBA and IMF, have urged banks to enhance monitoring and stress testing for resilience against dollar shocks. The increased exposure, particularly in securities financing and unsecured wholesale funding, suggests a systemic risk that could materialize if dollar financing were to dry up, as warned by ECB Chief Economist Philip Lane. This situation underscores a growing systemic risk within the European banking sector.

Key Decisions for Investors

• Investors should carefully assess the U.S. dollar funding and asset exposures of European financial institutions within their portfolios, given the EBA's reported increase in reliance and currency mismatch.
• Monitor regulatory developments and stress test outcomes from European banking authorities, as these will indicate the robustness of banks' resilience to potential dollar funding shocks.
• Consider implementing hedging strategies to mitigate currency mismatch risks for European bank holdings, especially for those with significant foreign currency liabilities or sub-100% Net Stable Funding Ratios.
• Pay close attention to macro indicators related to global dollar liquidity and U.S. monetary policy, as these directly influence the availability and cost of dollar funding for European banks.