Systemically important banks: Giants with feet of clay?

The buyout of Credit Suisse, a bank considered too big to fail, by its Swiss rival UBS, has brought back into focus the difficulty of saving socalled systemically important lenders. The buyout, announced by Swiss authorities over the weekend, hasn’t completely calmed the markets, testifying to the nervousness that pervades the financial system in the face of the pressure of rising interest rates.

What is a systemically important bank?

Credit Suisse was one of the around 30 largest lenders considered to be Global Systemically Important Banks, often considered “too big to fail”. These are designated by the Financial Stability Board, an institution created in the wake of the collapse of US investment bank Lehman Brothers to supervise reforms to strengthen the international financial system. They are required to hold larger capital buffers that are supposed to help ensure that they can absorb shocks.

The list includes JP Morgan Chase, Bank of America, CitiGroup, HSBC, Barclays, BNP Paribas, Deutsche Bank, Santander, UniCredit, UBS, as well as others including Credit Suisse.The lenders are considered so big that their collapse would have devastating consequences for the overall financial system and real economy, whether that is businesses or households.

The problem, for Thierry Philipponnat, chief economist at the NGO Finance Watch, is that “today, all of the banks have become systemic” and that the authorities feel compelled to intervene. He pointed to the failure of two banks in the United States earlier this month. Despite their moderate size, both were key to serving certain sectors of the US economy, which prompted authorities to rescue them to avoid a widespread bank crisis, with only limited success.

Why did Credit Suisse need to be rescued? For the past two years Switzerland’s number two bank had suffered a series of scandals that provoked huge losses. Confidence in the bank eroded and suddenly it had difficulty accessing funding at reasonable rates. The run on Silicon Valley Bank in the United States, which even if it had particular circumstances, still unnerved investors and depositors in the banking sectors. A similar state of panic in Credit Suisse was triggered last week when Saudi National Bank, its largest shareholder, said it wouldn’t invest any more capital.

Even if Credit Suisse’s reserves weren’t in a critical state, Swiss President Alain Berset said the takeover was the “best solution for restoring the confidence that has been lacking in the financial markets recently” and to prevent a run on the bank. According to the Financial Times and Blick, the bank’s clients withdrew 10 billion Swiss francs in one day at the end of last week.

What lessons can be learned? Even if the buyout by UBS, which was strongly encouraged by the authorities, was the best short-term solution, questions remain about its long-term impact. “Creating even bigger banks only multiplies the moral hazard risk”, said Finance Watch’s Philipponnat.

He said investors and executives don’t have to same incentive to adopt rigorous management because they know they will be bailed out in any event.

Economist Veronique Riches-Flores said she “isn’t sure this is the most efficient model in the medium to long term”. One can also question the efficacy of the numerous measures to bolster big banks taken after the 2008 crisis.

Credit Suisse met all the solvency criteria, and yet when faced with a crisis in confidence the authorities had to step in to arrange its buyout. Riches-Flores criticized comments from the European Central Bank that sought to calm markets. One “spark can quickly create a chain reaction that no one can anticipate”, she said. She said the Credit Suisse crisis was caused by the general uncertainty in the sector provoked by the failure of US banks that had no link at all with the Swiss lender. —AFP