It’s been a crazy few weeks in financial markets, with the failure of Silicon Valley Bank (SVB) on March 10 triggering increased market volatility, and we have now seen the panic claim several regional US banks and now banking giant Credit Suisse as victims.
And while it might be easy to jump to conclusions and assume that we are at the beginning of a financial crisis on the back of the fastest rate rise cycle in many generations, it is important to remember that panic itself was the real cause of the downfall of these banks. In the case of SVB, it was the forced liquidation of SVB’s portfolio of bonds that crystallised their losses and would not have occurred without a bank run aided by social media panic.
Credit Suisse, however, is a different kettle of fish altogether. Credit Suisse, unlike SVB, is one of the world’s largest financial institutions and its affairs are intertwined throughout the entire financial ecosystem. However, there is absolutely nothing surprising about the turn of events at Credit Suisse as the bank has faced management mistakes, scandal and mounting losses in recent years. Undoubtedly, the recent panic sealed Credit Suisse’s fate as its major shareholder announced it would no longer provide any further financial support, but Credit Suisse’s problems pre-dated the monetary tightening cycle.
So, it’s important to distinguish that while recent events aren’t the cause of Credit Suisse’s problems, ensuring its survival is of grave importance. The fact that the Swiss government effectively agreed to underwrite much of UBS’ risk in strongly encouraging the merger between the two Swiss banking giants speaks to the importance of Credit Suisse not turning into another Lehman Brothers. Central banks are walking a tightrope in slowing down demand without causing instability within the financial system, and the good news is that they have the experience of the GFC to learn from when responding, and the fact that resolutions were found so quickly for SVB and Credit Suisse is encouraging, even if the need for those resolutions is disquieting.
On a slight segue, it is notable that in invoking emergency powers to expedite the binding agreement that would see UBS buy Credit Suisse, the Swiss authorities prioritised equity holders ahead of some bond holders, with AT1 debt (Additional Tier 1, the equivalent of bank hybrids) facing a full loss while Credit Suisse shareholders will receive almost $5bn in payments. Wholesale bank hybrids have traded lower since the UBS/Credit Suisse deal was confirmed, and the arrangement upends the natural order where equity holders are wiped out first in the event of liquidation/insolvency. Central banks throughout the world have come out against the structure of the deal in trying to assure AT1 holders that their investments remain above equity holders in the natural capital hierarchy. In the case of Credit Suisse, this was only possible with the government invoking emergency powers, so we don’t think this is a realistic risk in Australia.
