The series of bank collapses in 2023 shook our belief system on the global financial system and its safety. In the overall scheme of things, post-COVID inflation and geopolitical factors (Ukraine War) have been bogging down the world’s financial system. Add the banking collapses in it, and things get messier further.
In its April 2023 ‘Global Financial Stability Report’, the International Monetary Fund issued a warning that “financial stability risks have escalated quickly as greater concerns about inflation and fragmentation have put the resilience of the global financial system to the test.”
Smaller emerging economies with significant debt and declining repayment capacity have the most unstable banks. The IMF expects a dire financial climate due to increased geopolitical concerns, unmanageable debt, rising inflation and interest rates, and tighter monetary conditions. It was closer than anyone admitted during those stressful March days.
“The lightning-fast, forced takeover of Credit Suisse by rival UBS had helped to avoid a national calamity,” Swiss Finance Minister Karin Keller-Sutter said in Washington in April.
Switzerland’s central bank director, Thomas Jordan, said the takeover prevented Credit Suisse from “being the first domino in a systemic collapse.”
A systemic crisis
The crises around United States’ banking majors like Silicon Valley Bank, Signature Bank, First Republic Bank and their Swiss counterpart Credit Suisse have revealed systemic problems that require immediate attention. There is a contagion worry around the financial circles in Europe and the United States, and this worry is now bothering regulators.
The Swiss government deserves recognition for moving fast and decisively to rescue Credit Suisse, as its quick deployment of resources prevented a 2008-style banking catastrophe.
On the other hand, American depositors were so nervous about the future of their deposits, that they started withdrawing those capital en masse from the domestic banking sector. The Federal Reserve too expressed worry, which didn’t help the matter either.
“It appeared like contagion from SVB’s bankruptcy may be far-reaching and inflict damage to the broader financial system,” said Fed vice chairman of Supervision Michael Barr.
Michael Barr also said that if the customers can’t access their money, depositors may start distrusting US commercial banks’ safety and soundness.
Potential risky behaviour
As we shall see, both banks somehow slipped the leash of risk-averse management that authorities imposed on them after 2008. The obvious question is: have the global giants returned to the reckless behaviour that caused the financial crisis?
After the Credit Suisse panic, French and German authorities raided five giant banks for possible money laundering and tax evasion on behalf of wealthy clients, highly illegal activities that had enraged regulators after the 2008 revelations of egregious behaviour.
Since 15 years of reforms were designed to eliminate banking shocks, the question is significant. National regulators ordered a wide range of measures that separated investment from deposit banking, boosted capital ratios and liquidity, sheeted home responsibility onto specific senior executives, eliminated sky-high undeserved bonuses, and, most importantly, ensured a tottering institution could collapse without triggering a house of cards, as happened in 2008. No bank could be “too big to fail.”
Meanwhile, authorities scrutinized systemically significant institutions (G-Sibs), which bankers sometimes hated.
Despite all this regulation, 49-year-old Silicon Valley Bank failed in 24 hours after what the US Federal Reserve called “a devastating and unexpected run by its uninsured depositors,” while once-mighty Credit Suisse was bundled into USB, its supposed rival, with indecent haste before it failed. Credit Suisse’s viability has long troubled Swiss regulators.
Credit Suisse might earn over $17 billion in 2022 from financing Swiss railroads. The second-largest Swiss bank seemed impregnable until a year ago. Swiss banks are known for their strength, dependability, and prestige. The major Swiss regulator, FINMA, is also held in high regard. The Swiss government had to quickly raise $122 billion to save Credit Suisse. The new guidelines say even a G-Sib’s failure shouldn’t cost taxpayers.
In the US, SVB was not for sale, even at gunpoint. The Federal Deposit Insurance Corporation, which ensures financial stability and confidence, followed the book, or “hierarchy,” as central bankers believe. The FDIC swiftly guaranteed SVB and Signature Bank’s insured deposits after a run on deposits caused them to fail. Troubleshooting regulators took over after the US Fed fired senior managers overnight.
Most significantly, the Fed guaranteed up to a year’s worth of liquidity to other banks, preventing future runs. As per the post-2008 hierarchy, SVB equity and liability holders lost their investments.
Speculation & effects
These failures have various effects. Credit Suisse, with operations in the US, Europe, the Middle East, and internationally, has substantially higher numbers. The effects may last for years. UBS, with $1.1 trillion in assets and $34.6 billion in sales, may be able to swallow its rival, mainly due to its doubtful assets. The takeover creates a $5 trillion entity, but nobody knows how much of Credit Suisse’s assets will be written down.
Credit Suisse stockholders lost money, and FINMA will value its tier-one bonds at zero. UBS will buy Credit Suisse for $3.3 billion, a fraction of its pre-failure value.
Reading between the lines, the US Fed was astounded by Silicon Valley Bank’s collapse. Supervisor Michael Barr told the House Committee on Financial Services that management’s failure to manage liquidity risk, its largest responsibility, and the run killed the bank. According to media reports, management prioritized development over stability and ignored internal stress testing that highlighted issues.
Why run, and why now? The Fed seemed bewildered and embarrassed. Michael Barr stated, “SVB’s failure warrants a full assessment of what happened, including the Federal Reserve’s monitoring of the bank.”
It is already known that SVB had a focused business model and that its customers were mostly in the high-risk but potentially lucrative technology and venture capital industries. The bank had been established for over four decades, but in the three years leading up to 2022, it tripled its assets as the IT sector boomed. Concerns should have arisen. Before 2008, fast-growing institutions like the Royal Bank of Scotland failed on both sides of the Atlantic.
The Fed says SVB invested fast-growing deposits in longer-term securities with higher yields without the necessary expertise: “The bank did not effectively manage the interest rate risk of those securities or develop effective interest rate risk measurement tools, models, and metrics.”
The bank also neglected its liability risks. Senior executives fell into the liability-asset mismatch trap. Media reports suggest some personnel had severe concerns about their boss’s decisions. SVB’s troubles stemmed from the technology sector’s need to hold cash deposits in the bank to cover salaries and operating costs. However, cash deposits can be removed at will and often are.
On March 8, SVB realized it wasn’t liquid enough and announced a $1.8 billion loss in a securities transaction but expected to raise funds the following week. That alerted its clients, and some of America’s brightest examined their bank’s balance sheet.
Michael Barr stated, “They did not like what they saw,” in typical US fashion.
On March 9, SVB clients withdrew over $40 billion, demonstrating how insecure a supposedly well-funded bank may be. SVB collapsed the following day as other depositors followed suit. The nightmare of regulators and bankers, an unstoppable run by depositors, took SVB down in three days.
Slow decline
Credit Suisse’s demise appears to be a case of bad management and, as the US Fed admits, supervisory errors, while SVB’s was a case of terrible management and political interference. Unlike in the US and UK, FINMA did not release more than 100 red flags to the bank regarding its many faults during its slow decline.
Credit Suisse was in trouble by 2021 due to $10 billion in losses on client funds invested in Greensill Capital, a massively indebted British supply chain finance firm, and $5.5 billion in US hedge fund Archegos Capital Management.
The integrated global finance sector failed both in 2021. Credit Suisse lost the most in these disasters. Former bank CEO Thomas Gottstein said these blunders were “awful.” Credit Suisse was unlikely to recoup any capital in Greensill and possibly none in Archegos at the time of writing.
These disasters followed years of risky investment banking by Credit Suisse, which had brought down US banks like Lehman Brothers in 2008. Wealthy clients fled, the share price fell, and the bank’s credibility, any institution’s most valuable asset, collapsed. Swiss Info, a Swiss Broadcasting Corporation magazine, says that the bank’s leadership is to blame.
Events quickly deteriorated. In October 2022, Swiss authorities installed a new management team to fix the investment bank firm. “The bank will build on its outstanding wealth management and Swiss Bank franchises,” it said, returning to its roots.
At the time, FINMA Chairwoman Marlene Amstead called this spring clean “a start in the correct direction towards risk reduction.”
The bank had a record-breaking client fund run in the same month. In the fourth quarter, withdrawals reached over $155 billion, and although Credit Suisse survived again, the writing was on the wall.
The two occurrences highlighted “too big to fail” for systemically important organizations. The financial crisis reforms created a two-part worldwide norm. The bank is either a “going concern” that can be saved or a “gone concern” that will be properly buried. The global standard defines a “going” bank as one that has enough capital to cover current business losses and a “gone” bank as one that can be restructured or liquidated.
The Credit Suisse takeover is the first real-world test of the “gone” part of “too large to fail.” No banking authority is ignoring this case study, which has garnered global attention. FINMA’s Marlene Amstead believes Switzerland did the right thing in a communal solution combining taxpayer money, the government, regulators, the central bank, and UBS’s consent.
However, Credit Suisse may have caused a financial disaster if it failed. Does that mean the entire “too big to fail” architecture must be overhauled after the debacle?
Regulatory failures
In a bank disaster, regulators must take responsibility, and they typically do. The Bank of England’s “regulation-lite” faith in management was abandoned during the Great Financial Crisis.
After SVB was classified as a higher-risk “big and foreign financial organization” with $100 billion–$250 billion in assets, its supervision was transferred to a new team. It’s not a G-Sib, but any organization with up to $250 billion in assets is important.
The new team instantly rated its enterprise-wide governance and controls “deficient-1” due to management concerns. Supervisors met with management in November 2022 to discuss rising risks, particularly in interest rates and liquidity, which pose some of the greatest threats to a bank’s integrity. They also worried about rising interest rates affecting SVB and other banks.
The supervisors did not anticipate that it would collapse so quickly. Banks and regulators often clash. While most banks follow the rules and want to follow supervisors’ advice, some must be judged. Because of judicial enforcement, regulators usually win with resistant banks.
Most of FINMA’s 40 annual enforcement proceedings in Switzerland never go public. FINMA conducts 600–700 investigations a year, which require inspectors to knock on doors “to clarify suspected infractions.” In nine out of 10 situations, banks take corrective action when presented with evidence, but Credit Suisse’s refusal was a significant issue.
FINMA states that institutions rarely ignore investigations and multiple judgments. Thus, Swiss authorities are privately discussing Credit Suisse’s case. No country can accept an institution that bullies the regulator, and Switzerland was exceptionally weak.
Central bankers like the Bank of England, the US Fed, and others can name names.
“As the events around Credit Suisse illustrate, our instruments reach their limits in severe cases,” says Marlene Amstead, who wants additional power. “An extension is worth considering.”
Historically, politicians have been hesitant to grant FINMA the necessary authority. Unlike France, the UK, and the US, FINMA lacks the ability to impose fines. Following a prolonged discussion, Swiss politicians ultimately voted against the merger of Credit Suisse and UBS.
Functioning properly
In a broad internal evaluation, the Fed asks if the regulatory regime is effective.
“Once discovered, can supervisors discern concerns that constitute a serious danger to a bank’s safety and soundness? Supervisor Michael Barr asked the House of Representatives, “Do supervisors have the instruments to reduce threats to safety and soundness?”
“The failure of SVB highlights the need to go on with our work to increase the resilience of the banking system,” he added.
Thus, supervisors should be tough before it’s too late. The US Fed wants to apply Basel III regulations to smaller banks like SVB because they can withstand losses better than the G-Sibs. The financial sector will be closely monitoring the Fed’s proposed new set of stress tests, which cover a wider range of risks and reveal contagion channels. That implies that present stress-testing technology fails.
Contagion is often irrational. In the current banking system, insured depositors get their money out, but dread spreads without explanation. Fintech’s emergence represents a hidden weakness in the post-2008 global banking system. They’re faster, cheaper, and more customer-friendly, weakening the giants’ financial dominance. For example, US banks are smaller.
US Fed Governor Michelle Bowman said, “De novo [new] bank development has largely frozen for the past decade during a period when financial services have quickly evolved.”
New banks are smaller, more conservative, and, surprisingly, safer.
“As we have seen over time, they often outperform larger banks during periods of stress like the pandemic and during the 2008 financial crisis,” Governor Michelle Bowman said.
They also treat small businesses better during rough times. That may drive depositors away from giants. Bank capital may be insufficient in the future. Regulators admit they weren’t before the Great Financial Crisis, and the latest concern is pushing for a reassessment.
Undercapitalized banks have serious repercussions. The 2008 banking crisis caused the longest and deepest recession since the Great Depression. America, the world’s wealthiest nation, saw six million foreclosures, 10 million people fall into poverty, and six years of job losses. Research suggests the impacts persist.
Central banks are worried about the resumption of the run on deposits, but nobody is predicting a worldwide banking collapse. In a post-Credit Suisse debate, Bank of England Governor Andrew Bailey said, “We’re in a very different place, and I genuinely don’t see this as the start of a systemic financial crisis.”
No central banker would disagree, but the tremors created by SVB and Credit Suisse’s collapse have revealed systemic flaws that must be fixed.