The collapse of Credit Suisse shows that more work is needed on banking risk

The writer is a managing partner and head of research at Axiom Alternative Investments

Bank investors are well aware of the risks; they know that banking is built on trust and that sentiment can change quickly. However, the Credit Suisse crisis is an unprecedented phenomenon.

I remember all bank failures were caused by hidden losses, be they in loan books, derivatives books or bond books. Even though the latest episode of market panic was triggered by the bond defaults of mid-sized US banks, there is no indication that the current Credit Suisse crisis stems from this problem. So how did this happen and what lessons can we learn from the crisis and the intervention of the Swiss authorities?

In volatile markets following the collapse of Silicon Valley Bank and Signature Bank, an embarrassing announcement by Credit Suisse’s largest shareholder that it would not provide further assistance was enough to send the bank’s share price soaring. Financial assistance is Chekhov’s bank weapon: mention it and it’s very likely that it will be used before the end of the play.

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It is no coincidence that Credit Suisse has become the main target of the markets. It has been embroiled in a series of scandals and management disputes for years. Sometimes the annual report appears to be nothing more than a long list of old and new litigation and an acknowledgment of poor risk management.

Consequently, CS has become the weakest link in the European global systemic banks. It’s a bit of a weird weak link because it had a lot of capital and liquidity. It’s not the only bank with low profitability, nor the only one with deposit outflows in the fourth quarter. And of course, this is not the only bank that has faced scandals over the years. However, this is the one that had all these weaknesses at the worst possible moment.

What were the options to stop the bleeding? The Swiss authorities didn’t really have a choice. In the end, Credit Suisse’s own clients decided its fate, not investors. They made up their minds and withdrew money. A merger with UBS is an obvious solution that was on everyone’s mind. The Swiss authorities may be criticized for allegedly not doing more to open up the bidding war to non-Swiss players, but can we really blame them? Does anyone remember a bank failure that was solved in a weekend with a foreign white knight?

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This is why UBS is in a very strong negotiating position. People will debate the possibility of litigation losses, more bad loans, or the cost of liquidating Credit Suisse’s investment bank. But UBS is paying a fraction of the bank’s shareholder equity, which was estimated at SFr45 billion ($49 billion) at the end of last year. Even after factoring in the likely sale of some of the Swiss retail bank’s assets to address competition concerns, this deal is likely to be very value-enhancing for UBS shareholders. Restoring customer confidence and low funding costs could also make a difference in profitability.

However, bondholders appear to be forced to take losses. In the longer term, this could raise financial stability questions, as this case was driven by market panic over a bank with high capital and liquidity, supported by its supervision.

There are many lessons to be learned from this crisis, but I hope the bottom line is that banking culture is too important to be treated lightly. Market fluctuations after internal failures or even a banker turning out to be a fraud can jeopardize the jobs of tens of thousands of hardworking people who will feel betrayed and maligned just because they worked for the wrong company. Regulators and investors have done a lot of work on this, but clearly there is still a lot to do.

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Axiom trades bonds from Credit Suisse and other banks