Economic experts believe that the collapse of Credit Suisse will have global consequences.
The contract worth over 3 billion Swiss francs allowed everyone – at least for a few hours – to breathe a sigh of relief, and they said – this must not happen. Global authorities have spent more than a decade reforming the banking sector to prevent taxpayers from bailing out the system, as they did during the 2008 crisis by keeping them away from public money in the event of a collapse. No one should be ‘too big to fail’ now. But in recent days, a different story has been going on, from the failure of Silicon Valley Bank (SVB) to the failure of Credit Suisse.
“If you look at the numbers, it’s a small problem for global banking, if you look at the consequences, they are huge”, Thijeri Filiponat, chief economist of the non-governmental organization Finance Watch, told Politiko about the collapse of SVB. “What does that tell us? The market doesn’t think the rules in place are enough to deal with bank volatility.”
If boring Switzerland can’t, who can?
In Switzerland, however, as Europe’s 19th largest lender, Credit Suisse, collapses – becoming the most dramatic banking casualty since the 2008 financial crisis – there are still concerns that it is the first domino in a chain that stretches around the world. And if boringly safe Switzerland can’t save its banks, who can?
On Sunday, Swiss authorities forced the Zurich-based bank to merge with its longtime domestic rival UBS. The contract worth over 3 billion Swiss francs allowed everyone – at least for a few hours – to breathe a sigh of relief. The goal was to protect investors and savers and stop a complete banking crisis.
Temporarily this was achieved, but the devil, as usual, is in the details. As the markets picked up the corpse of Credit Suisse, alarm bells began to ring. The way the Swiss organized the rescue could, in fact, have made matters worse.
Crisis like 2008?
Since the 2008 crisis, regulators have tried to prevent troubled financial institutions from ‘infecting’ each other with their problems by choosing to impose losses on bondholders rather than depositors and taxpayers. But even those who held the riskiest type of bond were confident that wouldn’t happen until shareholders first paid the bill. Back to the beginning
Last week’s chaos in Europe seems to be abating after all. However, the panic it caused shows how quickly confidence can evaporate in the face of bankruptcy and how a rise in central bank interest rates could create losses that would spread throughout the financial system. And that’s a big problem.
The latest banking scalp, Credit Suisse, performed better than required by regulations – but was still bleeding deposits, as investors sold off its shares and debt. “The markets didn’t believe it“, says Sebastian Mack, political associate for European financial markets at the Jacques Delors Center, a research center based in Berlin.
With public money back on the line, despite years of reforms to prevent taxpayers helping out the crisis, confidence in the rulebook is now further under question. “What is clear is that in the end, the American and even the Swiss authorities used public money,” says Jonas Fernandez, a Spanish member of the European Parliament from the ranks of socialists and democrats.
Although governments did not directly inject cash, they provided a guarantee of stability, which contradicts the basic assumption of post-crisis rules — that banks should be able to fail in an orderly fashion, without draining money from public coffers.
“Even small banks have become too big to fail. It’s pretty amazing,” says Philipponat of Finance Watch. “And it’s almost a little depressing that after 12 years of debating ‘How do we make sure this doesn’t happen again?’ ‘, everything seems to bring it back to the beginning.” In reverse order…
In the case of Credit Suisse, Swiss regulators reversed this common practice. First, they wiped out bondholders, causing financial panic throughout the system. “Those who had ties to the regulators tried to prevent them from doing it, for that very reason,” an expert on bank liquidity at the International Monetary Fund, who wished to remain anonymous, told Politiko.
It is a classic example of how an infection can spread to the entire system. If investors suddenly think their bonds are riskier than before, this can lead to a sell-off, pushing prices down and undermining confidence in the entire system. If an unexpected wipeout of those bondholders causes their prices to fluctuate wildly, banks could see their funding costs rise significantly, exacerbating their problems, bank analysts at JP Morgan warned.
In an attempt to calm nerves after the Swiss decision, a trio of European supervisors — the Single Resolution Board, the European Banking Authority and the supervisory arm of the European Central Bank (ECB) — issued a joint statement to reassure investors that in the event of a bank collapse in the EU, they would shareholders who suffered first.
The Bank of England also intervened. “Holders of such instruments should expect to be exposed to losses on resolution or insolvency according to the order of their positions in this hierarchy,” the statement said. In other words: no panic. Same but different However, Credit Suisse’s collapse raises serious questions about to that was the system as tight as the ‘banking police’ thought it was?
By all regulatory measures, the bank was well capitalized and had plenty of liquidity. This could mean that the rules introduced after the 2008 crisis are not as strict as people are led to believe. And if that’s the case, we could be in real trouble. The specificity of the Credit Suisse case provides some comfort. The bank’s problems started a long time ago and bear little resemblance to the problems that brought down California’s Silicon Valley Bank (SVB) two weeks ago.
Swiss authorities confirmed that Credit Suisse was not exposed to higher interest rates in the way that SVB was when they decided to support the bank with a 50 billion Swiss franc loan. When that reassurance failed to stem panic in the bank’s share price, markets turned to broader questions about Credit Suisse’s reputation, culture and profitability.
Spy scandal
Things came to a head last week, when Saudi National Bank – one of Credit Suisse’s investors and part-owned by Saudi Arabia’s sovereign wealth fund – signaled it was not ready to inject more capital into the group.
Credit Suisse’s woes, however, are spreading. Under pressure to make its investment bank profitable as increased regulation clipped its wings, the bank hired former insurance executive Tidjane Thiamkao as CEO in 2015 with a mandate to turn things around. His immediate response was to launch a comprehensive restructuring program by cutting thousands of jobs, cutting costs and shrinking the investment banking division. The effort ran into trouble, however, when the investment banking division began to struggle to keep up with its rivals and, worse, was embroiled in a series of loss-making scandals, including a $5.5 billion loss linked to the collapse hedge fund Archegos. A spy scandal, in which the bank monitored its employees, forced the executive to leave.
Credit Suisse’s Board of Directors then appointed Thomas Gottstein as Chief Executive Officer. Gottstein vowed to continue Thiam’s efforts to restructure the bank, but said more needed to be done to address deep-seated cultural problems. His 2021 term has been rocked by his involvement in the failed financial firm Greensill Capital. The bank was again forced to change – Gottstein had to resign.
A new plan was unveiled in 2022 under the bank’s last chief executive, Ulrich Kerner, which included further cuts to the investment banking division, as well as a renewed focus on asset management and other core businesses. The bank also pledged to take steps to address its risk management culture and practices in order to prevent future scandals.
But the outbreak of war in Ukraine and the imposition of sanctions have stifled the bank’s ability to serve the asset management needs of some of its wealthiest clients. Plans to spin off the group’s investment arm under the revived Credit Suisse First Boston brand, which operates out of New York, hit a snag in February when it became clear the bank would have trouble finding investors to fund the operation amid concerns about how creditors would be ranked in the event failure of the whole group.
The collapse was only a matter of time
“I’ve seen other banking crises. This is not a full-blown crisis where governments save their banks at all costs,” said one EU diplomat, who wished to remain anonymous.
The weaknesses revealed in the banking system are likely to deal a blow to those who want stricter rules faithfully enforced. EU regulators on Monday reaffirmed that the Union’s regime for failed banks has not changed, to try to calm investor fears over Switzerland’s decision to reorder who bears the losses in the collapse of Credit Suisse.
Brussels is now under increasing pressure to come up with a plan to close the loopholes for failed mid-sized banks. “The European Commission must present this proposal as soon as possible,” Fernandez said. According to him, the bloc should now become tougher with smaller lenders and impose strict requirements on banks’ exposure to cryptocurrencies — as US technology bank SVB shows what can otherwise happen.
Mak believes that the EU should now reconsider the softer approach and introduce fewer deviations and perhaps stricter rules for government bonds. “The system is fragile and that is why we need to transfer internationally agreed standards, so that we are not vulnerable”, he concluded.
(WORLD)