The financial world is in a tizzy with the collapse of Credit Suisse, a “too big to fail” Global Systemically Important Bank (GSIB), which is least expected to go down. Coming as it did within ten days of the first of four mid-size US bank runs – from Silicon Valley Bank (SVB) to Signature Bank, Silvergate Bank and First Republic Bank – this turn of events is bound to shake public trust in banking and regulatory oversight more than we think, notwithstanding the immediate relief provided by their respective governments, regulating authorities and other banks with a rare joint statement from six central banks (from the US to the UK, Europe, Canada, Japan and Switzerland) to boost the flow of US dollars.
It is all the more shocking because Credit Suisse was being tracked and monitored by multiple regulators and institutions across the world simultaneously and it was supposed to follow stringent banking and disclosure norms of Basel III as a designated global SIB. Its failure actually marks the failure of the new global financial order put in place after the 2007-08 financial crisis to particularly avoid recurrence.
What is a Global Systemically Important Bank?
Following the 2007-08 financial crisis, the G-20 leaders set up the Financial Stability Board (FSB) in 2009 as a successor to the Financial Stability Forum (FSF) with a broadened mandate to ensure international financial stability. Starting with 2011, the FSB designates 29 to 30 banks as GSIBs every single year in consultation with the Basel Committee on Banking Supervision (BCBS) and national authorities.
The FSB is headquartered in Switzerland’s Basel city; Credit Suisse is based in another Switzerland city, Zurich – a global hub of banking and finance. Basel III (which takes its name after Switzerland’s same Basel city) containing various rules on capital and liquidity also came up in 2010 and is an improvement on the Basel II framed in response to the 2007-08 crisis (improved further in 2017).
The FSB’s first list of 2011 made the significance of designating “too big to fail” (TBTF) financial institutions – called Systemically Important Financial Institutions (SIFIs) at the time, intending to separately identify banks, insurers as well as non-bank non-insurers which later metamorphosed into GSIBs. Its report said: “SIFIs are financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity. To avoid this outcome, authorities have all too frequently had no choice but to forestall the failure of such institutions through public solvency support. As underscored by this crisis (2007-08), this (failure) has deleterious consequences for private incentives and for public finances. Addressing the “too-big-to-fail” problem requires a multipronged and integrated set of policies.”
Notice how the concept of the bailout was institutionalised (“through public solvency support”) in the new global financial order.
Credit Suisse has been on the GSIB list since 2011. Ironically, the last list naming it as a GSIB was published on November 21, 2022 – 119 days before its takeover by UBS was announced (March 19, 2023) – indicating the futility of all the tracking, monitoring and tougher banking and disclosure norms that the status of GSIB entails, like (a) higher capital buffer (b) total loss-absorbing capacity (TLAC) (c) group-wide resolution planning and regular resolvability assessments and (d) higher risk management functions, risk data aggregation capabilities, risk governance and internal controls.
The TBTF was the logic the US government used to nationalise Fannie Mae and Freddie Mac, provide liquidity support and facilitate the takeover of Bear Stearns, AIG, Lehman Brothers etc. during the 2007-08 crisis. But the concept of TBTF goes back to 1984 when another such occasion arose involving another bank, the Continental Illinois National Bank. Literature shows, TBTF arises out of institutions (practices and laws) such as bailouts, limited liability, regulatory forbearance, forgiving resolution procedures, deposit insurance, lenders of last resort, and preferential treatment of large versus small banks.
Also note that a bailout is not a new concept but traces its history to Wall Street’s first collapse in 1792 (231 years ago), which entailed a rescue act by the US government.
But the moot question remains unanswered: Why should a bank be allowed to grow to be TBTF or too big to pose systemic risk in the first place?
Duncan Watts, Columbia sociologist and network scientist, had argued in 2009 that instead of going by the regulators’ judgment calls about systemic risks – which failed in the case of Lehman Brothers then and Credit Suisse now – a better approach “would be for regulators to routinely review firms and ask: “Is this company too big to fail?” If yes, the firm could be required to downsize or shed business lines until regulators were satisfied that its failure would no longer pose a risk to the whole system.” His article was aptly titled “If Too Big to Fail? How About Too Big to Exist?”
Bail-in and bail-out
The US and Switzerland officials object to the use of world “bailout” (given the notoriety it acquired during the 2007-08 crisis for rewarding rather than punishing the bankers and other wrongdoers) but there is no escaping it now.
The US government has appointed the government-run Federal Deposit Insurance Corporation (FDIC) as “receiver”, is facilitating mergers and takeovers along with regulators and also providing liquidity along with other banks to save its banks. President Biden has assured that all deposits are safe. Notwithstanding the claims of not bailing out, Amiyatosh Purnanandam, a US corporate economist who studies bank bailouts said: “If it looks like a duck, then probably it is a duck. This is absolutely a bailout, plain and simple.”
The case with the Switzerland government is similar.
It has (i) brokered the takeover of Credit Suisse by another Swiss bank UBS at $3.3 billion (at a 60% discount to on $8.7 billion market value of Credit Suisse at the time) (ii) has given a guarantee of $9 billion to the USB against the potential loss from this takeover – more than the acquisition price and market value of the Credit Suisse ($3.3 billion and $8.7 billion, respectively) and also (iii) giving liquidity assistance of $108 billion.
There is another element in it, called “bail-in”.
That is, the Credit Suisse bondholders have lost their entire $17 billion. This “bail-in” is the provision of depositors and bondholders forfeiting their money, which the Indian government wanted to bring in through the Financial Resolution and Deposit Insurance (FRDI) Bill of 2017 (proposing that in case a bank fails the depositors’ money will be used to bail it out, as one of the resolution tools) but the idea was abandoned due to stiff resistance.
Credit Suisse’s failure has been a long-drawn process.
Its market value was rapidly falling for about two years (from over 12 Swiss Franc in 2021 to about 2 in mid-week and then to less than 1 now). The trigger was its large shareholder Saudi National Bank publicly refusing to pump in money last week, plunging its market value to a new record low.
Just days before the bank run, Credit Suisse reported (i) “material weakness” in its financial reporting for 2021 and 2022 – issues related to a “failure to design and maintain an effective risk assessment process to identify and analyze the risk of material misstatements” and various flaws in internal control and communication. This escape from detection for two years is strange given its status as a GSIB.
Further, this revelation came after a series of scandals involving investments, banking practices, management and worse in the past two-three years: (ii) in February 2023, it reported net loss of more than 7 billion Swiss francs for 2022 and warned of a substantial loss in 2023 (iii) it was convicted in cocaine-related money laundering which involved a Bulgarian gang (iv) a Bermuda court ordered compensation of $600 million due to fraud committed by its former advisor (v) Panama Papers-like investigations into its secret accounts (leaked data on thousands of customers) (vi) lost $5.5 billion when US family office Archegos Capital Management defaulted in March 2021 (highly leveraged bets on certain technology stocks backfired) (vii) forced to freeze $10 billion of supply chain finance funds in March 2021 when British financier Greensill Capital collapsed and Swiss regulators rebuked it for “serious” failings in handling business (viii) CEO Tidjane Thiam was forced to quit in March 2020 in a spy scandal, after an investigation found the bank hired private detectives to spy on its former head of wealth management Iqbal Kahn after he left for arch rival UBS.
Nouriel Roubini, known for accurately predicting the 2007-08 Great Recession, warned that the SVB’s collapse had had a “ripple effect” and that Credit Suisse could prove to be a “Lehman moment” (when one institutional failure spreads to another).
Cost of undoing or lack of banking reforms
The US adopted the Glass-Steagall Act of 1933 following the 1929 Great Depression (sparked by banking failures, stock market crash), effectively separating commercial banking (traditional banking) from investment banking (not traditional banking) to restrict bank credits being used for speculative activities (stock market) and instead direct it to productive use in industry, commerce and agriculture. Essentially, this prevented the use of retail deposits (or bonds) to fund investment banking activities. This was reversed in 1999 by the Clinton administration, and it played up in the 2007-08 crisis again. But the situation remains unchanged yet (although in 2020 the US Congress made a strong case for breaking the monopolies of tech giants Apple, Amazon, Facebook and Google).
In contrast, though equally harmed by the 1929 crisis, Europe did not go the whole hog for such separation. Most of it adopted the “universal banking” model in which both commercial and investment banking went hand-in-hand, which endures. In a 2019 reform (“ring-fencing”), the UK requires banking groups with more than £25 billion of retail deposits to split their retail and investment banking activities into legally separate subsidiaries. Credit Suisse, as well as the USB, are both universal banking entities.
The other is the Dodd-Frank Act in 2010, adopted by the US after the 2007-08 crisis, which applied tougher regulatory oversights to smaller banks (asset threshold of $50 billion). This was weakened (the threshold was raised to $250 billion) in May 2018 by the Trump administration. Ironically, Federal Reserve chair Jerome Powell, who was part of this dilution is now fighting to save the SVB and other banks that escaped scrutiny precisely because their assets were less than the $250 billion threshold.
Food for thought
Now consider a few things going forward.
Why not break banks and companies “too big” too big to pose systemic risk, as the Columbia sociologist suggested, instead of celebrating them as “too big to fail” or GSIBs and then bailing them out “through public solvency support”? Multiple such entities have crashed in the past 15 years – from the Lehman Brothers, Fannie Mae, Freddie Mac, Bear Stearns, AIG to Credit Suisse. Why shift the risks of their failures resulting out of their unethical and illegal acts to the public (banks or individuals through tax)?
As for the other factors for these bank runs, why not revert back to more prudent interest rates, rather than near zero for long periods of time; tighter monetary supply, instead of creating debt-fueled enterprises through liquidity infusion; higher corporate tax rates than individual tax rates; tighter regulation on stock markets’ speculative activities, rather than let them be called ‘casino’ and ‘ponzi’ scheme; tighter capital flow, rather than the deregulated or lightly regulated and unhindered global flow of capital; lifting the corporate veil on secret banks, tax havens and shell companies and tighter regulatory oversight, rather than a lax one?
Remember, the Golden Age of Capitalism was during the 1950s-1970s when both developed and developing countries registered the highest ever GDP growth (3.8% and 3%, respectively), the average top corporate tax rate was 70-80% in the US and 99.25-80% in the UK and there was tight control on capital flow and banking activities.
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