11  The rising cost of Tier 2 debt owes, at least in part, to smaller banks issuing these instruments to comply with MREL resolution requirements. This factor may have had an important impact, given that MREL requirements are binding from 1 January 2022 and banks must reach the required levels. 12  The balance of bank deposits held by the resident private sector in Spain rose by 4.1% in 2021, compared with growth of 8.9% in 2020. In March 2022, deposits increased by 5.1% year-on-year, compared with rates of over 7% in the same month a year earlier. 13  In 2021, the cost of capital increased over the first ten months of the year, from 6.4% at December 2020 to 10.8% at October 2021, and then fell back over the last two months, standing at 8.1% at year-end. Thus, the average cost of capital for the full year was 8.8%, in any case below the sector’s ROE. 14  So far this year the cost of capital has continued to fall, to 7.3% in March and 6.9% in April, below the ROE for 2022 Q1 (11.7%). 15  The CET1 ratio and its denominator (risk-weighted assets (RWAs)) recorded similar declines (0.9% for CET1 and 1.1% for RWAs), so the ratio rose by barely 2 basis points (bp) to 13.3% at end-2021. 11  Indeed, at December 2021, the leverage ratio of Spain’s significant banks (5.7%) was only slightly below the European average (6%).
On that basis, it was possible to build a whole architecture of asset prices, whose relative riskiness is determined according to the intrinsic characteristics of assets and investors’ risk appetite. The important word here is “relative”. To price financial assets, markets need a basis – a risk free rate. That basis has now been shaken. Immediate consequences seem benign in the US. Markets have judged, and rightly so, in my view, that there is currently no alternative to US debt as the most liquid market and it remains the ultimate benchmark for assessing risk. So, if anything, the downgrade of US debt was followed by new inflows into Treasuries and a decrease in US interest rates across the yield curve. At the same time, however, a pervasive uncertainty has been created, which might be  BIS central bankers’ speeches  1  responsible for the strong decline in confidence and equity prices that has occurred over the last weeks. In Europe, of course, sovereign credit risk has had more immediate and dramatic consequences, with an abrupt increase in sovereign spreads for peripheral countries following the July 21st statement. It remains difficult to foresee how, in the longer run, markets will assess debt sustainability in different countries and jurisdictions. That assessment depends on a complex process, where, together with economic fundamentals, subjective probabilities, self-fulfilling beliefs and other influences play a major role. The certainty that debt would be paid in full strongly anchored market perceptions in the past.