The Credit Suisse chaos shows just how scared the world is

It shouldn’t be necessary. Credit Suisse is a designated globally systemically important bank, subject to stringent capital adequacy and liquidity requirements and intense supervision. It has a common equity tier one capital adequacy ration of 14.1 per cent and a vast hoard of cash and other liquid assets – the equivalent of about $190 billion of liquid assets within a $860 billion balance sheet – to call on.

It does have a substantial exposure to corporate deposits, which tend to be much less stable than retail deposits and which, as was seen in the US bank failures, can make a bank more susceptible to a run. The high levels of liquidity and the willingness of the Swiss central bank to provide a backstop do, however, provide insurance against that possibility.

Moreover, the group weathered massive outflows of funds last year, most of it in the December quarter when customers pulled about $180 billion out of the group. That forced it into a major restructuring that will reduce costs and risk and release significant amounts of capital and cash.

Credit Suisse is not just too big to be allowed to fail, but there is, therefore, no obvious reason at this point why it would.

Unlike the Silicon Valley and Signature banks it doesn’t hold large quantities of government bonds and therefore isn’t sitting on a massive pile of unrealised losses as a result of the surge in global interest rates (and consequent fall in the value of bonds and other fixed rate securities). In any event, systemically important banks mark the value of their holdings to market.

It is the exposure to unrealised losses on bond holdings that, in an environment where central banks are rapidly pushing up interest rates (and pushing down the value of existing bonds) to combat inflation, has made banks more vulnerable to a run.

To generate the liquidity to enable customers to cash out their deposits, they have to sell the bonds and realise those losses on securities that would otherwise be held to maturity without loss. It was a decision – under pressure from mounting redemptions by depositors – to sell $US21 billion of bonds at a $US1.8 billion loss that condemned Silicon Valley Bank.

It was inevitable that, with the Fed raising US rates by 450 basis points within 12 months and other central banks following in behind it, albeit not as aggressively, that the abrupt shift in monetary policies would generate some stresses within the financial system.

It was only last year that the European Union ended its decade-long experiment with negative interest rates (pity those banks still holding those negative yielding bonds today). A year ago the US federal funds rate was almost zero.

There’s been a dramatic and quite abrupt shift in global monetary settings and banks – because the post-financial crisis settings have required them to hold large amounts of unquestionably “safe” securities and therefore have big holdings of low-yielding government bonds – were in the front lines as the tide of monetary policy turned.

The problems exposed in the US banking sector this week have created a febrile environment.

Credit Suisse won’t be the only bank targeted by the fearful or predacious.

Problems large enough and threatening enough to force the Fed to effectively guarantee all the deposits in the US system, while also offering to buy securities from the banks at par (which means the banks won’t crystallise the losses they would experience if they had to sell those securities into the market) would tend to do that.

It isn’t, therefore, surprising that there is an intense search underway for other vulnerable banks. Credit Suisse won’t be the only bank targeted by the fearful or predacious.

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That a bank of such global systemic importance could be at risk of being overwhelmed in this intensely risk-averse moment will provide even more food for thought for the central bankers and, with a meeting looming next week, the Fed in particular.

Silicon Valley and Signature shouldn’t have represented a threat to the stability of the US financial system, but the Fed’s actions suggest strongly that it believed they did. At what point does prioritising the effort to reduce inflation risk another financial crisis that envelops those institutions of clear systemic importance? Let’s hope we don’t find out.

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