Credit Suisse and the likely impact on banking regulations
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Credit Suisse and the likely impact on banking regulations

- Liquidity levels in the banking sector are running at about five times that of 2007, with quantitative easing having added around $10 trillion

- Credit Suisse suffered from a combination of governance issues and deposits being concentrated among high-net-worth investors and mostly unguaranteed

- Banking spreads are around 11% wider this year, compared with the wider market which is only 1% wider

- Regulators will look to liquidity ratios as quantative tightening kicks in

The past few weeks have seen the most turmoil in banking markets since the global financial crisis (GFC) of 2008 / 09. In the GFC, banks had loaded up with sub-prime mortgages and structured credit. Write-downs of those assets caused a capital problem and investors pulled the funding. Subsequent regulation solved for this, with the intervening years seeing the banking sector building layers of Core Tier 1 capital, Additional Tier 1 capital and loss-absorbing senior debt, so governments are no longer on the hook to provide capital to banks.

 

As such, the banking sector entered this current crisis period with record levels of capital and strong earnings built upon rising margins. Liquidity is also at record levels. Quantitative easing (QE) has added around $10 trillion of deposits into the system over the past decade. In 2007 the aggregate loans-to-deposits ratio across the UK, the eurozone and the US was in excess of 115%; it is now less than 80%, meaning there are far more deposits than loans in the system. In addition, liquid asset portfolios are running at around five times the levels they were in 2007.

 

So, if capital and liquidity are at record levels, what happened to Credit Suisse? This crisis didn’t follow the GFC playbook, meaning there was no asset quality or capital problem at Credit Suisse. The bank had three layers of loss-absorbing capital – CT1, AT1 and bail-in debt – totalling CHF99 billion (or 40% of risk-weighted assets) to protect depositors. In other words, it could incur CHF100 billion of losses before depositors would be at risk.

 

Instead, Credit Suisse suffered from a governance problem, compounded by a liquidity problem. Much has been written about the governance at Credit Suisse, from the Mozambique loans case1 and the Archegos and Greensill scandals2,  to the group’s former chair, Antonio Horta-Osorio, breaking Covid quarantine rules to attend the Wimbledon tennis finals3. Alongside this, the Credit Suisse liquidity problem was one of deposits being concentrated among high-net-worth investors (around 65% versus a sector average of 10%) and mostly unguaranteed (only 15% versus a sector average of 50%). Such deposits are “flighty” and behave more like wholesale funding than retail deposits. So, from the reputational damage on the governance front to depositors with less sticky money, problems arose despite the huge layers of capital designed to protect investors. 


Future banking regulation

This now means that those institutions which are more dependent on such deposits are likely to be under heavier market scrutiny, while those with higher retail deposits are in a more advantageous position. It also means some banks will have to pay more to attract deposits from “safer” competitors and from money market funds – US funds last week saw in excess of $100 billion being deposited4.

 

This in turn risks a tightening in lending standards and financial conditions. All in all, increased turmoil means banking spreads are around 11% wider this year on the European senior banks index compared with the wider market, which is only 1% wider.

 

The Basel III rules, introduced in response to the GFC, addressed liquidity problems through the liquidity coverage ratio (LCR), but it was originally conceived when depositors physically had to visit a branch to withdraw funds, leading to the infamous queues outside Northern Rock. The LCR is designed to ensure banks have enough liquidity to withstand a 30-day period of outflows. However, it only assumes that 10% of the more flighty deposits leave. Credit Suisse reportedly lost more than CHF10 billion or 4% of deposits per day at the end of last week, and SVB lost 25% of uninsured deposits in a single day.

 

As such, regulators are likely to recalibrate the test to account for the faster movement of deposits in the age of internet banking on mobile phones and events blowing up on social media. It may also penalise concentrations amongst the deposit base. All in all, this should lead to banks holding more cash.

 

We do not think the focus on deposits will go away anytime soon. As quantitative tightening kicks in, the aggregate banking sector deposit base will shrink. The $10 trillion of QE liquidity across the US, UK and eurozone is equivalent to more than 25% of the current deposit base. We expect the roll-off of funding programs like the European Central Bank’s TLTRO(Targeted longer-term refinancing operations) and the Bank of England’s TFS (Term Funding Scheme) to add to the tightening.

 

As liquidity is withdrawn, competition for deposits will hot up. As investors we will certainly be scrutinising management teams more on the relationship between governance and liquidity. We believe the cost of funding is now higher across the sector, especially for banks with a weaker deposit mix. Valuations have, however, adjusted and there are areas where banks look attractive relative to other sectors.

27 April 2023
Paul Smillie
Paul Smillie
Senior Credit Analyst
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Credit Suisse and the likely impact on banking regulations

1 FCA, Credit Suisse fined £147,190,276 and undertakes to the FCA to forgive US$200 million of Mozambican debt, 19 October 2021

2 Forbes, Credit Suisse, Burned By Archegos And Greensill Scandals, Shifts Focus To Wealth Management In Overhaul, 4 November 2021

3 BBC, Credit Suisse boss Horta-Osorio resigns over Covid breaches, 17 January 2022

4 Bloomberg, as at 20 March 2023

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For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.


In the UK:
Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.


In the UK:
Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

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