How has the failure of Silicon Valley Bank (SVB) and concerns with Credit Suisse affected European markets? We gathered our banking analysts, strategists and fixed income professionals to discuss recent events and the implications for markets in Europe and globally. Our panel included Michael Brown, Global Head of Investment Strategy and Oversight Executive, Martin Currie, Annabel Rudebeck, Head of Non-US Corporates, Western Asset Management Company, and David Zahn, Head of European Fixed Income, Co-Chair of the Sustainability & Stewardship Council, Franklin Templeton Fixed Income.
- What is the connection between SVB and the events surrounding Credit Suisse? Without the SVB crisis, it is unlikely the liquidity of Credit Suisse would ever have been called into question. Credit Suisse has several issues: First, there were already concerns around planned strategic changes to its business announced last October. Then, this week, its annual reporting demonstrated material weakness in cash flow accounting. Then, we had what we would consider skewed media reporting about the Saudi National Bank not increasing their stake; so, by Friday, fears that the bank had more severe governance risks and no backstop liquidity naturally became a concern to the markets. In our view, Credit Suisse’s liquidity coverage is sufficient, but the market was reacting with fear, especially after what happened to SVB—that is why we saw the support announcement from the Swiss Central Bank Wednesday night.
- Is the announcement from the Swiss Central Bank enough to stem systemic risk? We think so, for the moment, and more support could be on the horizon. We believe authorities are poised to step in if needed to avoid further contagion—perhaps not on the equity side but definitely to protect depositors. Historically, banks like the Swiss National bank have intervened during times of crisis, like COVID-19 or the global financial crisis (GFC). We think the market likes the intervention, but the market is still questioning whether it is enough.
- Is the Credit Suisse situation idiosyncratic or systemic? We would argue the Credit Suisse situation is unique and not an indication of a systemic problem across the European banking industry. European banking regulations are tighter than in the United States, and we would argue for the better. The notion of what is cash on a balance sheet versus what are considered high quality assets is not a concern at European banks like Credit Suisse because of the way European banks are regulated. What matters for Credit Suisse is their liquidity coverage ratio (LCR), which reflects the bank’s high-quality liquid assets divided by their potential net cash outflows over a 30-day horizon in a stressed environment. This LCR is specific to each bank, customized—but on average across Europe, it is about 163%.1 Currently at Credit Suisse it is about 150%.2 The question is: What comprises a high-quality asset? SVB had high-quality assets—US Treasuries—but they were long-term and thus had duration risk and had fallen in value as interest rates rose. At Credit Suisse, more than half is cash held at central banks, and the rest is government credit risk, which is marked to market. The bottom line is that the notion of what is cash versus high-quality liquid assets is not a concern at Credit Suisse and other European banks generally, as opposed to what we may see in the United States.
- Will we see more regulation following on these events? Almost certainly, most notably in the United States and particularly for smaller banks. Up until recently there were loud voices in the marketplace clamoring for less regulation, but this past week has likely quelled that noise. We anticipate US banking regulations to become more European in nature. The bailout of SVB depositors, for example, is itself a European approach. Of note, institutions and corporations are now looking more closely at bank diversification, considering how they diversify where their cash is held, but also how to diversify across fixed income. This could mark the dawn of a new era as investors diversify their cash base to avoid this type of exposure going forward.
- What to expect from central banks and rates going forward? Despite the banking sector jitters, we don’t expect we will see interest rate cuts from central banks anytime soon. Inflation is still their number one priority, as is the job market. Both are still very high. The European Central Bank just raised rates 50 basis points (bps). We believe the US Federal Reserve (Fed) will also continue to hike rates, as just last week Fed Chairman Jerome Powell was talking about not just a 25-bp hike, but a potential 50-bp move.
- Who are potential winners against this backdrop? Presumably large US banks with cash on their balance sheets and excess deposits to liabilities. Flows will go to the big banks because everyone knows they are “too big to fail.” This is a problem in the United States, as there is already too much concentration in the big banks. Naturally, smaller banks will likely struggle. Structurally, Europe’s banking system is much more consolidated than in the United States, so there is not the same competition for deposits. The SVB situation also shined a bright light on the differences between European banks and US banks as it pertains to venture capital and technology, which require very different banking needs over time. Perhaps over time private debt investors will meet some of the venture capitalists’ needs.
- How reliable are the LCR’s for banks like Credit Suisse? Given its significance, the wholesomeness of any LCR information is of great concern to investors. A lot of the ratios that banks are required to measure are designed for semi-stress situations, so the question is: How do you define that environment? In our view, it is important to remember that even in the most extreme circumstance, banks like Credit Suisse have been offered a US$50 billion backstop, with likely more to follow. As such, any extreme outflows are most certainly protected. This should provide reassurance to all depositors. Central banks are making commitments so enormous that depositors should not feel panic about any bank names currently, in our view.
- What to do with any banking-related fixed income allocations in the European Union going forward? First and foremost, we will see heightened volatility—without question—for the remainder of the year. Just looking back at the diametrically opposed behavior of the markets from January to February, we can get an idea of what to expect ahead. We’re looking at short duration and see some good opportunities in the banking sector. We are also looking at companies in the industrials area, and we believe sustainable bonds will be a good opportunity going forward as well.
- What could happen for this to become a serious liquidity crisis that affects everyone? In our view, we would need to see an enormous and dramatic deposit flight from Credit Suisse, which we do not believe will happen. Other potential stress situations could include a ratings agency downgrade, which recently happened at First Republic Bank, as well as any counterparty risk exposure. In both cases, the current central bank liquidity back stops would be enormously helpful in calming depositors and avoiding a panic.
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1. Source: European Banking Authority. Data as of 2022.
2. Source: Credit Suisse press release, as of March 16, 2023.
