By Chiara Elisei and Amanda Cooper
LONDON (Reuters) - Confidence in European banks deteriorated further on Friday, with the cost of insuring against a debt default rising sharply as the profit outlook for the sector dimmed.
Global banking shares and broader markets have been rocked since the sudden collapse this month of two U.S. regional banks and a forced merger between Credit Suisse and UBS.
Policymakers have stressed the turmoil is different from the global financial crisis 15 years ago because banks are better capitalised and funds more easily available.
But this has failed to stem a selloff in bank shares and bonds, with rising funding costs in fixed income markets adding to the banking sector's woes and clouding their profit outlook.
Deutsche Bank's five-year credit default swaps (CDS) jumped 19 basis points (bps) from Thursday's close to 222 bps, rising to their highest since late 2018, data from S&P Global Market Intelligence showed. They later eased back slightly.
UBS's five-year CDS shot up 23 bps from Thursday's close to 139 bps, S&P data showed. CDS prices move up when the default risk is seen to be rising.
"We'll probably see regulators look to act to restore confidence because what we do know is that confidence is key to the whole concept of banking and it is hard to win and it's easy to lose," said Mark Dowding, chief investment officer at BlueBay Asset Management.
In the United States, the support could mean guaranteeing more bank deposits, Dowding said.
Banking stocks fell sharply across Europe, with heavyweights Deutsche Bank and UBS hit hard.
"Underlying sentiment is still cautious and in this environment no one wants to go into the weekend risk-on," said Nordea chief analyst Jan von Gerich.
The prospect that interest rates may be close to peaking, as financial markets are signalling, would also curb banks' profit margins on lending.
European banks' Additional Tier 1 (AT1) debt came under fresh selling pressure, with Deutsche AT1 prices down 6 cents, according to Tradeweb data.
UBS and Barclays AT1s fell roughly 2.5 cents in price, respectively, Tradeweb data showed.
The selloff in AT1s highlighted concerns about rising funding costs for European banks and helped explain why the sector was facing renewed pressure on Friday, analysts said.
With AT1 bond yields sitting at 12%, far exceeding the return on equity, the AT1 market was no longer a "viable funding source" for banks, said Saxo's head of equity strategy Peter Garnry.
The implication is that banks would potentially have to issue new shares to raise cash.
"The banking crisis is far from over and the impact on credit conditions and the economy will likely be felt over the next six months," said Garnry.
Federal Reserve chief Jerome Powell on Wednesday said banking industry stress could trigger a credit crunch with "significant" implications for the economy.
Markets are also pricing in U.S. interest rate cuts and a chance of a rate cut in the euro area by the end of the year -- moves that would also eat into banking margins.
AT1s meanwhile have been hurt since the Swiss regulator ordered 16 billion Swiss francs ($17.5 billion) of Credit Suisse's AT1 debt to be wiped out as part of its rescue takeover by UBS last weekend.
Shareholders, who usually rank below debt investors when a company becomes insolvent, will receive $3.23 billion.
Although authorities in Europe and Asia have said this week they would continue to impose losses on shareholders before bondholders - unlike the treatment of bondholders at Credit Suisse - unease has lingered.
(Reporting by Chiara Elisei and Amanda Cooper; Additional reporting and writing by Dhara Ranasinghe; Editing by Susan Fenton)