Avoiding contagion

Credit Suisse collapse shows need to focus on stability

The collapse of Credit Suisse, a storied Swiss institution only a few years younger than the Swiss Confederation itself, is at some levels hard to explain. There is no clear link between the troubles in the US banking sector — led by the problems at now defunct Silicon Valley Bank (SVB) — and questions about Credit Suisse. As pointed out last week by analysts at Citibank, there should be “limited read-across from the failure of Silicon Valley Bank” to banks in Europe, which, analysts said, “have less deposit concentration, are still seeing healthy deposit flows, operate with large liquidity portfolios, and remain well capitalised”. This seems to demonstrate the US banking system had idiosyncratic flaws, caused, in part, by Washington’s decision to regulate only certain banks as systemically important. One bank in Europe, however, did stand apart from the description: And that was Credit Suisse, which has been seeing steady deposit outflows for several quarters in a row — for a total of $133 billion in 2022.

The bank was suffering from a series of management scandals and lurid infighting, which included physical altercations and accusations of surveillance; and it was already vulnerable since, unlike its Swiss rival UBS, it had an under-performing investment banking arm. When, last week, the Saudi National Bank —a major Credit Suisse shareholder — said it would not be throwing good money after bad, Credit Suisse found itself unable to survive. While the liquidity fears brought on by SVB’s collapse may have been partly to blame for the timing, Credit Suisse’s collapse is not necessarily a reflection of a broader contagion.
 

Yet the nature of its end and its takeover will have repercussions for regulators and investors in the banking sector globally. The Swiss authorities swiftly put together a deal that will fold Credit Suisse into UBS; from their point of view, given that Credit Suisse’s problem was mistrust of the management and not bad assets, it was necessary to act to protect those assets and retain Swiss leadership in private banking. The government set up a liquidity backstop to prove it was serious. Meanwhile, since —to save time, perhaps — Credit Suisse was not formally going under, shareholders could not be polled about the takeover. So to ensure their acquiescence, they were promised about $3 billion, allowing Credit Suisse to call its fall a “merger”. But, to help finance the deal and to ensure Credit Suisse was a little more creditworthy when it went to UBS, the lowest tier of Credit Suisse’s bonds — $17.3 billion worth of “additional tier 1” bonds — was wiped out. This is what the $275-billion AT1 bond market was designed for after the financial crisis — to finance a “bail-in” if a bank is close to failing. Yet bondholders are furious that equity will get something and they don’t. It remains to be seen if AT1s will survive this decision.

For regulators the world over, there are lessons from this episode. Credit Suisse had pre-existing problems that caused its fall, merely accelerated by the difficult moment. Perhaps the most important lesson was underlined by Chief Economic Advisor V Anantha Nageswaran recently, when he argued that “margins of safety” on operations were crucial, for both investors and regulators. In India, the biggest source of risk is fiscal: The government must continue to concentrate on macro-economic stability in the face of troubled times ahead.