Banking crisis: how dangerous is the crisis at Credit Suisse for the financial system?

There are several reasons why Credit Suisse shares fell by up to 30 percent on Wednesday: First, the entire banking sector has been under pressure since last week.

Banking crisis: how dangerous is the crisis at Credit Suisse for the financial system?

There are several reasons why Credit Suisse shares fell by up to 30 percent on Wednesday: First, the entire banking sector has been under pressure since last week. The bankruptcy of the Silicon Valley Bank (SVB) in the USA, after all the number 16 among the largest banks in the country, sent shock waves through the entire industry. Customers around the world feared for their deposits, which increases the theoretical risk of a bank run.

"The crisis has developed its own dynamics," states Hans-Peter Burghof, Professor of Banking and Financial Services at the University of Hohenheim. In order to bring calm back to the heated mood, Credit Suisse (CS) borrowed CHF 50 billion from the Swiss National Bank overnight. In this way, CS and the Swiss central bankers want to show that liquidity is secured and that there is no danger.

CS has been in the spotlight for many months because it was involved in numerous scandals, including the bankruptcies of hedge fund Archegos and asset manager Greensill. Last year, CS posted a record loss of CHF 7.3 billion. And the management is also expecting a loss for the current year. So investor confidence has been shattered for some time. "Many consider Credit Suisse to be the world's weakest systemically important bank," said Burghof.

In addition, there is now the banking crisis in the USA and a statement by the major shareholder Saudi National Bank (SNB). In an interview with the Reuters news agency, President Ammar Al Khudairy announced that he would not inject any additional money to save CS. There are regulatory reasons for this, because the SNB already holds 9.9 percent of CS and more extensive reporting obligations arise from 10 percent, but the market initially saw this as a loss of confidence in CS.

Many investors saw this as an indication that the bank's liquidity problems were greater than communicated. The equity ratio of CS is actually very solid at 14.1 percent - and as a so-called "systemically important bank", CS also has to meet even higher requirements than smaller banks. But none of this helps when there is a deep crisis of investor confidence. So the stock price plummeted.

The decisive factor for the unrest was the bankruptcy of the SVB, which was placed under state control last Friday. Since then, the industry has been in turmoil: customers withdrew their deposits from smaller banks and preferred to park them at large banks that are considered safe, such as JP Morgan or Bank of America. US President Joe Biden and the SEC intervened in communication and secured the deposits at the SVB. However, the global price slump continued - also because only deposits and no stock values ​​were secured.

The current interest rate policy is also causing problems for many banks. "The central banks are driving the vulnerability of the industry through their rapid interest rate hikes," says banking expert Burghof. Savings banks as well as Volksbanks and Raiffeisenbanks recently had to correct the values ​​of their fixed-income securities because these have lost enormously in value due to the rise in interest rates. In total, they had to write off around 14 billion euros.

Connections between the problems at Credit Suisse and US banks are at best indirect. However, the events in the USA do show the vulnerability of the financial system, says banking professor Burghof. The three closed banks were medium-sized and important for the US, but not nearly as important internationally as CS. This is one of the 40 banks that are officially classified as systemically important. This is less due to their absolute size than to their connections to other market participants.

Conversely, the 40 systemically important banks have so far not included any large US companies such as JP Morgan or Bank of America, but only insolvent regional banks such as SVB, Signature Bank or Silvergate. In this respect, the connections are primarily psychological in nature. The imbalance of the SVB disrupts the balance between trust and distrust in the capital markets. In this situation, investors sometimes react extremely. "As soon as liquidity is questioned, investors try to withdraw their money. These doubts have been sown at Credit Suisse," says Burghof. "That makes the situation problematic."

The bankruptcy of the SVB has nothing to do directly with the difficulties at Credit Suisse. The business model of the SVB, which specializes in tech companies, differs greatly from that of Credit Suisse, which, as a major European bank, primarily looks after very wealthy international clients. "Credit Suisse is in a different league than Silicon Valley Bank. I don't see any contagion effects from the USA on Credit Suisse," says Burghof.

Indirectly, however, Credit Suisse is suffering from the consequences of the US banking crisis: The markets are extremely nervous and have therefore reacted with excessive sensitivity to the news about difficulties at Credit Suisse.

The US regulators had to close the SVB last Friday due to liquidity shortages. The bank miscalculated above all in the so-called "maturity transformation". Because of the low interest rates, the SVB has invested in low-risk long-term government bonds - such as ten-year US government bonds, which still yielded 0.53 percent in July 2020. However, when the rapid turnaround in interest rates set in last year, this became a problem, especially for growth companies - the largest customer group of the Silicon Valley Bank. They withdrew so much money from their accounts that the SVB had to sell fixed income securities to get fresh money. Because of the rise in interest rates, however, she sold the securities with large losses. The attempt to raise new money from investors failed.

That depends on how much trust is placed in banks and regulators. One thing is clear: no bank in the world easily survives a bank run. However, that is also the worst case – and there are many different gradations in between.

Regulators also have tools at hand to convey security. For example, in which they protect deposits like in the USA, even if they are above the secured sum of 100,000 euros in the EU. All values ​​below are subject to statutory deposit insurance anyway. A systemic risk of infection currently seems implausible. Banking expert Burghof sees "no domino effect" threatening the European banking sector. For this, larger players in the US, which are more closely linked to European banks, would have to fall. In any case, the German banks have recently been robust and did solid business.

It is not possible to make a final assessment at this point in time. However, the situation now is very different from that in 2008. In the run-up to the global financial crisis, the Lehman Brothers Bank had issued bad real estate loans that were worthless. Lehman had sold these to other banks on a large scale until each eventually had such junk loans - and the system collapsed.

The case of Credit Suisse and that of Silicon Valley Bank is different, which is why Burghof says: "We are definitely not as far as we were with the 2008 financial crisis." A failure of Credit Suisse would be a "significant problem" for Europe and would have noticeable side effects. According to his assessment, however, the failure would be "still tradable". The banks in the European financial sector are, for the most part, solid. If there were a threat of a bank collapse, the ECB would also intervene and probably do everything to stabilize the financial market.

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