Recent bank-runs in the United States and the European Union have raised uncomfortable questions about whether financial regulatory reforms over the past decade have been sufficient to safeguard financial stability
Over the past month, a global systemically important financial institution and a regional bank in the United States have both fallen into distress, despite complying with current capital and liquidity requirements. A closer look at how market sentiment contributed to these events is crucial for future remedial action and policy planning.
Nervous sentiment triggers crisis at Credit Suisse
A crisis of confidence among already-jumpy global investors played a major part in the downfall of Credit Suisse. The 166-year-old institution has been besieged by a series of compliance failures, poor investment decisions, and senior managerial turnover since 2020.
At the same time, the bank was also considered well-capitalized and compliant with international regulatory capital requirements. At the end of 2022, Credit Suisse had a Common Equity Tier 1 ratio of 14.1% and a liquidity ratio of 144%, both substantially higher than applicable requirements.
In a staff memo issued in late September, ahead of an announcement on the outcome of a strategic review, Credit Suisse CEO Ulrich Koerner advised staff not to confuse the bank’s day-to-day stock performance with its strong capital base and liquidity position. That statement proved insufficiently reassuring.
Credit Suisse customers withdrew roughly CHF 110 billion (US$119 billion) from the bank last year, mostly during the fourth quarter. Additionally, the reputational damage from enforcement actions, leadership turnover, and investment losses have left the organization increasingly vulnerable to systemic events. This February, Credit Suisse disclosed that in 2022 it had suffered its biggest annual loss since the global financial crisis in 2008. Investors reacted, and the bank’s shares plunged by 15% upon the disclosure of the results.
A panic sale ensued on March 15, following new reports that Saudi National Bank (SNB) had ruled out additional investment in the Swiss bank beyond its existing 9.88% stake, due to regulatory constraints. Despite subsequent clarification from SNB chairman Ammar Al Khudairy that any investment above 10% would trigger regulatory hurdles both domestically and internationally, investors reacted to the remarks by heading for the exit in droves, withdrawing billions as the bank’s share price continued to fall. Despite also expressing confidence in Credit Suisse, describing it as a “strong bank” and saying SNB’s investment was opportunistic and long-term, Al Khudairy’s vote of confidence came too late.
The subsequent sell-off was so impactful that even a credit line from the Swiss National Bank failed to restore confidence. On March 19, UBS announced it would take over Credit Suisse, with the former left as the surviving entity once the transaction closes.
Contagion fears spur bank run at First Republic Bank
The recent run on First Republic Bank is an even starker illustration of the potential systemic threat posed by nervous market sentiment.
Following the collapse of Silicon Valley Bank (SVB) and Signature Bank, concerns of contagion among smaller, regional banks prompted depositors to withdraw money from such institutions in the U.S., in favor of larger financial institutions. First Republic Bank was among some of the firms to experience a bank run from those outflows.
The bank sought to respond swiftly to assure investors by disclosing that it was financially sound and had obtained additional financing to withstand potential systemic risks posed by the collapses of SVB and Signature Bank. At the time, bank capital and liquidity at First Republic Bank were considered well above the regulatory standard for well-capitalized banks in the United States. The bank also has a fairly clean compliance record.
None of these assurances, however, were sufficient to stem customer outflows or keep the bank’s share price from sinking. U.S. regulators and a consortium of large financial institutions are in discussions to provide additional emergency liquidity to First Republic Bank.
Regulatory considerations of broader financial crisis
Regulators are emphasizing that the current environment differs significantly from the period preceding the 2008 financial crisis. They point to years of regulatory reform since then, aimed at ensuring banks are better capitalized. Some supervisors have also hurried to hint at plans for more regulation, including higher bank capital requirements.
Indeed, this crisis differs from 2008. This crisis of confidence in the banking sector is also a crisis of confidence in bank supervision. Significantly raising capital standards to the point where financial institutions should — in theory, at least — be able to withstand the scale of recent bank runs without raising capital, would have drastic implications for retail and commercial lending, at a time when the world is anxious about economic growth.
Setting aside the potential impact on small-to-medium business growth and the opportunity for wealth generation among lower net-worth demographics, further curtailing credit would also affect higher-risk but meaningful initiatives to advance the environmental, social, and governance (ESG) objectives to which many nations and industries have committed.
When a global systemically important bank and a compliant regional lender — both considered well-capitalized above regulatory requirements — fall into distress within the same month, despite regulatory assurances, authorities may need to consider a risk-management approach that speaks more directly to a trepidatious and distrustful global market.