Banking is a massive, complicated and delicate confidence trick. Normally it works fine. But as soon as people worry that it could fall apart, it often does, sometimes spectacularly.
So when an old friend, an entrepreneur in Geneva, messaged me last week to say he had moved his money out of Credit Suisse, having already taken his company’s account elsewhere, it was clear that Switzerland’s second-largest lender was in trouble.
The 167-year-old institution, with a SFr531bn balance sheet and more than 50,000 employees, was sold to its bigger Swiss rival for SFr3bn in a rescue deal at the weekend orchestrated by government authorities that almost completely wiped out its shareholders. By all accounts, Credit Suisse was not given much choice about whether to accept it.
What caused such a dramatic demise of what was until recently still one of Europe’s 25 biggest banks? Is this a sign of a wider crisis brewing in the European banking sector?
The first point to make is that Credit Suisse has been the problem child of European banking for several years after suffering multiple scandals, losses, management shake-ups and restructuring plans.
When three midsized US lenders, including Silicon Valley Bank, collapsed earlier this month following a rapid withdrawal of depositors’ money, investors started to fret about which other banks could be vulnerable.
Credit Suisse caught their eye. Having already seen rich clients pull more than 10 per cent of their money out of its wealth management unit in just a few months last year, the bank was still suffering outflows of cash, at one point topping SFr10bn a day.
The run on deposits only accelerated last week after the chair of the Saudi National Bank, which bought a 10 per cent stake in Credit Suisse last year, unhelpfully ruled out providing the Swiss lender with any more financial assistance.
European regulators have rushed to express their confidence in the strength of the region’s banks. Luis de Guindos, vice-president of the European Central Bank, said last week that the sector was “resilient”, with much higher capital than in the previous crisis a decade ago, robust liquidity levels and “quite limited” exposure to Credit Suisse or the failed US banks.
De Guindos added that rising interest rates were “positive in terms of the margins of European banks”. Increasing the interest they earn on loans faster than the rate they pay to depositors helped eurozone banks to achieve a 7.6 per cent return on equity last year, the highest for over a decade.
Bad loans, long the Achilles heel of eurozone banks, have fallen steadily from over €1tn eight years ago to below €350bn last year, equal to less than 2 per cent of total loans.
However, while Europe’s banks are undoubtedly in a stronger position than in the previous crisis, when several had to be bailed out by their governments, this does not mean they will be immune to the latest turmoil.
There are several reasons to worry. First, Credit Suisse also had healthy capital and liquidity ratios — both only slightly below eurozone averages last year — but that did not save it once confidence evaporated.
Second, eurozone banks are still not earning enough profit to cover their cost of capital, which is around 9 per cent for many of them, meaning they are effectively destroying shareholder value.
A further concern is the flipside of rising interest rates, which the ECB have increased at an unprecedented pace to tackle soaring inflation. This will hit the value of the banks’ vast holdings of government bonds, mortgages and other debt.
Banks mostly account for these loans as if they will own them to maturity, so they do not take losses when their value falls. And many insure themselves by hedging interest rate risk. But the ECB’s head of supervision Andrea Enria said recently that many lenders were unprepared for this new environment, which would “create winners and losers”.
More broadly, the whiff of fear in financial markets is likely to make lenders much more cautious, reducing the flow of credit, increasing the risk of a recession and raising stress in already vulnerable areas such as commercial property — none of which is good for banks.