What might emerge from the Credit Suisse chaos?
Another week, another monumental news story in banking.
The UBS <> Credit Suisse (CS) tie-up has been the backdrop to another jaw-dropping week. And not because there were any major disasters on CS’ balance sheet (unlike SVB), but precisely because there weren’t any disasters.
A new type of crisis
CS had endured a bad run of fines and scandals, which hit its profitability and meant shareholders have had it rough in recent years, even before the events of the past week. But unlike with Lehman or SVB, there was no pool of toxic assets that precipitated the fall.
In fact, things at CS were in pretty good shape. In February this year, they reported a CET1 ratio of 14.1% for YE 2022, well above its 10.5% limit. Their liquidity coverage ratio was 144%, compared to a minimum of 100% and they had plenty of cash on hand to deal with deposit outflows. Or, at least that is they had deposit outflows for "normal” circumstances.
But the past 10 days have taught us that in a world armed with online banking, there might be no such thing as a “sufficient” liquidity coverage ratio. CS was never close to insolvent. In fact, it emerged from the GFC in better shape than its peers and it didn’t need a bailout (unlike its acquirer, UBS). All it had to spook investors and depositors was a string of bad news.
As Crispin Odey summarised this week, “The real secret here is that UBS has bought out its only rival for $3bn and it’s probably worth $30bn. This is not a bank like SVB, which had the wrong positioning. It was just very clumsy.”
Nowhere to hide
For years, clumsiness and bad news was something that shareholders paid attention to, but not depositors. The recent events at SVB have changed that. As Martin Wolf of the FT points out:
“Governments want [banks] to be both safe places for the public to keep their money and profit-seeking takers of risk. They are at one and the same time regulated utilities and risk-taking enterprises. The incentives for management incline them towards risk-taking, just as the incentives for states incline them towards saving the utility when risk-taking blows it up. The result is costly instability.”
That unstable equilibrium is more at risk in a world of digital payments and fickle sentiment that changes at the speed of a Tweet or a post. It’s not unreasonable now for anyone with deposits over the insured limit to ask, “should I just move everything to JPM or HSBC?” The US Fed is scrambling by contemplating raising the deposit guarantee for other regional banks to stop contagion.
Where does it end?
I have no crystal ball, but in Martin Wolf’s article, he proposes four solutions, the last of which should warrant some serious consideration. Not because it’s necessarily overwhelmingly preferential, but there’s a chance that we might end up there by default. As Wolf explains:
“Abandon this attempt to combine the provision of money with risky loans in one sort of business…members of the public could now hold central bank money directly. That was impossible when access to banking required branch networks but it would now be possible for everyone to hold central bank digital currencies that are perfectly safe, in any quantity. This idea would make the central bank the monopoly supplier of money in the economy. Management of the digital payment system could then be handed over to tech companies. The money created by central banks could be used to fund the government (by replacing government bonds) or be invested in other ways. Meanwhile, risk-intermediation could be done by funds, whose value would move with the market.”
Banks inherently combine 2 different (but related) services:
Holding your cash for you in a safe place.
Providing credit to individuals and corporations that need it.
For centuries, in an analogue world, combining the two services made a lot of sense. It wasn’t perfect and there were bank runs every now and then, but it broadly worked. In the 20th century, regulators tried to make the industry work better by imposing safeguards, but those safeguards were focused on solvency (ie, regulating good assets vs bad assets). CS is a cautionary tale because it was very solvent. But, what the regulators haven’t been able to do, is protect banks against a crisis of confidence and thus, liquidity.
Information wars
In today’s world, the velocity of information and action is so high, that the risk of a liquidity crisis is much higher than in the pre-internet days.
After the CS episode, one might reasonably conclude that all banks are at risk of a depositor run. If governments agree that protecting depositors is a social good, then providing a truly risk-free deposit product, in the form of a central bank digital currency (exactly as the BoE proposed last month), might be an answer. As for credit provision, specialist lenders have popped up providing personal loans, car loans, mortgages and more, and they fund themselves by securitising those loans and selling them to hedge funds and asset managers, or issuing covered bonds, or plenty of other sources that aren’t gathering deposits. For the first time, precisely because the tech is now available, it may well be possible to separate the two core services that banks provide.
I won’t try to predict whether this is likely or not. As we mentioned a few weeks back when we discussed Britcoin and CBDCs, questions of privacy and government control of money still loom large and instil caution. However, while I believe the “online payments” feature of a CBDC is largely unnecessary given pre-existing instant payments infrastructure, the “completely government guaranteed” feature of CBDC suddenly has a lot more importance than it did a month ago. As for credit provision, European policymakers have for a long time been trying to grow the capital markets as a share of funding for the economy, reducing the influence of the major banks, with initiatives like the Capital Markets Union. A catalyst like this might finally make it a reality.
