Systemically Important Banks After Credit Suisse
Bottom Line: The Group of Central Bank Governors and Heads of Supervision (GHOS) recently (here) underlined that risk management and governance should be the 1stsource of resilience followed by supervision including prompt correction action and then a prudent and robust regulatory framework. This will help most major bank institutions in the coming years, but falls short of what the SNB felt was required in the initial aftermath of the Credit Suisse emergency rescue. Banks with a poor narrative still risk confidence being tested by markets in times of weakness. Stress tests in recent months suggest that Global Systemically Important Banks (G-SIB’s) should be able to navigate arising problems, but certain 2ndtier bank institutions remain at risk. We are most sensitive about 2ndtier China banks given the multi-year fallout from the steep residential production construction decline (here).
The spring U.S. regional banking crisis and Credit Sussie saga have prompted stress tests and reviews from regulators around the world with no sustained crisis in the banking system. Will bank stability remain on the backburner as a macro and market issue?
Figure 1: Global Systemically Important Banks Tier 1 Capital
Source: SNB Financial Stability Report (June 2023 here).
Reflections on the U.S. regional bank crisis prompted a sense that the Fed needs to be more proactive with small and mid-sized banks, but that the FDIC safety net worked and the failed banks did not reflect a system wide issue. Though other regional banks have some reliance on wholesale deposits, it is not to the degree seen by Silicon Valley Bank (SVB). The same holds true for most banks realised losses on fixed income instruments in contrast to the large SVB losses. Regional banks still need to weather rising NPL’s from the problems in the U.S. commercial property sector, but this is a slower moving story rather rapid electronic withdrawal of deposits as occurred this spring. The market thinking is that tensions can return for small group of institutions, but this should not be a systemic or macro policy issue.
The same assessment cannot be made for the Credit Suisse saga however. Credit Sussie’s emergency rescue by UBS stopped problems cascading still further towards failure. However, the June SNB financial stability report report was critical on equity and liquidity buffers, despite them appearing adequate (Figure 1).
In particular, the SNB was critical that regulatory liquidity ratios were insufficient in the face of rapid electronic deposit withdrawals. Since 2008, bank customers have shifted more on line and away from bank branches. This means that fears over a bank can quickly cause an electronic bank run that eats into liquidity buffers irrespective of deposit guarantees, as depositors can move deposits more easily and rapidly. This requires major central bank liquidity lines to stabilise cash flow and confidence for the market and potentially individual institutions. On equity capital, the SNB had a two main areas of concerns; the delay in wiping out AT1 bond holders and the lack of reassurance from meeting regulatory equity capital (Figure 1). The decision to delay AT1 bond holders being wiped out until a rescue had to be mounted probably reflects Credit Suisse’s management apprehension that wiping out AT1 holders could hurt already-tarnished credibility despite improving the balance sheet. Meanwhile, the lack of reassurance for the market in meeting regulated equity capital probably reflects the wider narrative around Credit Sussie and its saga of repeated failures plus the inability of management to convince all stakeholders that the bank could be restructured successfully.
The Group of Central Bank Governors and Heads of Supervision (GHOS) recently (here) underlined that risk management and governance should be the 1st source of resilience followed by supervision including prompt correction action and then a prudent and robust regulatory framework. This will help most major bank institutions in the coming years, but falls short of what the SNB felt was required in the initial aftermath of the Credit Sussie emergency rescue. Stress tests in recent months suggest that Global Systemically Important Banks (G-SIB’s) should be able to navigate arising problems. The Fed (here), ECB/EBA (here), BOE (here) are some of the central bank stress tests, though some are outstanding and would be good to see. Indeed, the comfort with the stress tests saw the FSB focusing more on other issues in its letter to the G20 summit, including non-banks.
Figure 2: Solvency Stress Test for Systemically Important and Non-Systemic Banks
Source: PBOC 2022 Financial Stability Report (here)
However, banks and non-banking with a poor narrative still risk confidence being tested by markets in times of weakness. One area of monitoring is the scale of NPL’s from the residential property decline in certain DM countries (Canada and Sweden), but the stabilisation of property prices is tempering the scale of the problem.
Our biggest concern remains the fallout from the sharp decline in China’s residential construction (here), which could lead to a rise in bank and non-banks NPL’s.The PBOC’s most recent stress tests published May 2023 found resilience for the 19 domestically systemically important banks (D-SIB’s) (including China 4 G-SIB’s) but 363 non D-SIB banks were in the red worrying levels 8 to 10 (Figure 2) – all part of the PBOC’s early warning system. These are mainly rural banks and cooperatives (217) and village banks (118), but also 13% of city commercial banks (16). These red institutions are 1.55% of total banking assets and so in aggregate are currently not systemic, but timely restructuring/takeovers are required to reassure the financial system (here).