News of the week summary - 19/03/23

Credit Suisse, Switzerland’s 2^nd largest bank, taken over by UBS

Credit Suisse is the second largest bank in Switzerland by assets under management. Its main business is wealth management for fortunate clients around the world, and it also works as an investment bank.

In 2021, the bank faced a 4B$ loss due to Archegos Capital’s failure. The following year, its share price dropped to an all-time low after it reported a 1.6B$ loss (before taxes) in the 4^th quarter, and informed that wealthy clients were withdrawing important amounts of money amid financial fragility rumors concerning the bank. In 2022, deposits fell by 40% while assets dropped 30%.

This week, the stock price received a death blow after SVB’s failure raised contagion concerns for other banks, and CS’ biggest shareholder (Saudi National Bank) said it wasn’t planning on increasing its investment in CS (citing regulatory rules that prevent banks from holding more than 10% of other banks, since SNB already owns 9.9% of CS). This amplified concerns regarding the bank’s profitability, thus causing a further drop in the stock price, and a surge in credit default swaps prices to insure Credit Suisse bonds. Other banks saw their share prices significantly decline, notably Société Générale (-15% during the week) and Deutsche Bank.

To restore confidence in the banking system, the Swiss National Bank said it would provide liquidity to Credit Suisse if needed. The bank then quickly announced it was indeed borrowing 50B$ from the National Bank. This could have been done more to reassure clients and investors by reinforcing its balance sheet, rather than because CS really needed the liquidity to face withdrawals. This was not enough to reassure markets however, as the share price declined again a day after the announcement.

Because clients took their money out of CS which thus risked becoming insolvent, and to prevent further erosion of confidence in the banking system, Swiss authorities have prompted UBS (the biggest bank in the country, which has twice the amount of assets under management Credit Suisse has) to buy Credit Suisse for more than 3B$. Swiss legislation is expected to be modified to allow UBS to buy CS without shareholders’ approval. The National Bank has said it would provide more than 9B$ to compensate the losses UBS could face by taking over CS. It has also provided more than 100B$ of liquidity to facilitate the deal.

 

The ECB raises interest rates by 0.5 percentage points

Despite growing financial instability after SVB’s collapse and a fall in banks’ share prices in the Eurozone, the ECB has kept steady in its fight against inflation and raised interest rates by 50 basis points, to 3%. It has promised emergency support for eurozone banks if needed and will make future decisions based on coming data. According to the Wall Street Journal, the lack of guidance in the ECB’s statement is a sign it is prepared to slow down the rate increase.

The ECB is dealing with a tricky situation: it must bring inflation down (which it intends to do by raising interest rates), while preserving financial stability (although higher rates risk weakening banks as the fall of SVB has spectacularly demonstrated), and be careful not to make indebtment too costly for the most financially fragile eurozone countries.

Smaller balance sheets for regional banks could slow investment for small and medium businesses

After the fall of SVB and Signature Bank, and concerns regarding other regional banks, clients of these small firms could pull their deposits and place them at bigger banks considered safer. Even if they don’t, small banks could get more cautious and lend less of their money.

This would be an important problem for small and medium businesses, as they heavily rely on these smaller banks. Indeed, according to research by João Granja and Christian Leuz, in 2016 more than 75% of business loans under 1M$ in the US went to borrowers that were less than 50 miles from the closest branch of their lender. This is especially true in real estate and construction, as banks outside the 25 largest American banks represent two thirds of commercial real estate loans, and 70% of construction loans.

Over the years, local businesses have developed personal links and confidence with regional banks, making access to credit easier. If small banks’ lending capacity decreases and local businesses have to ask bigger firms for loans, the big bank will offer them credit at a higher cost since it will have less information on the business and its trustworthiness.