This analysis was published on 27/03/2023. Given the fluidity of the situation; Cushman & Wakefield will provide updates as pertinent information becomes available.
#1 Is Europe at Risk of Contagion?
Probably not. Credit Suisse should not be seen as a domino falling in reaction to what has happened in the U.S., nor should it be viewed as a suggestion that a systemic sequence of failures is expected. For contextual background, Credit Suisse has been plagued by a series of scandals and financial losses unique to its own history, and its challenges were unrelated to the interest rate risk and flight of uninsured depositors that several U.S. regional banks are confronting (including those that failed in recent weeks).
Credit default swap (CDS) prices for Credit Suisse underscore the known and very unique circumstances and problems facing the bank for some time. Its CDS price had gapped out significantly compared to other major European banks in recent days. For example, the average CDS price for a major U.S. or European bank was up 55% between March 1, 2023 and March 16, 2023. For Credit Suisse, it was up over 216%.
Although Credit Suisse has a long timeline of misfortunes, the latest “longer-term” sell-off in Credit Suisse's shares began in 2021, with the collapse of investment fund Archegos and Greensill Capital. To add to their troubles, Saudi National Bank, which, after investing $1.5 billion in November 2022, was the largest shareholder of Credit Suisse with 10% of shares, reported publicly that it will not be investing more money into the bank due to its own regulatory constraints. Credit Suisse ranks amongst the world's largest wealth managers whose failure would have caused huge ramifications for the entire financial system, which is why Swiss financial authorities were quick to release a statement of support confirming the country’s central bank would provide it with liquidity if necessary. Such swift reassurance was not enough to calm market unease and, as a result, Swiss authorities had to look for a private sector solution. A competitor of Credit Suisse, UBS, stepped in to rescue the bank, spending $3.25 billion, creating the world’s fourth-largest bank by assets.
Who’s Next and What Does This Mean for the Wider Banking System?
The big question on everyone’s mind is whether there are other institutions under stress which may be vulnerable to difficulties due to market conditions. (Note that this concern, while natural and legitimate, is very different from those relating to U.S. issues and those relating to issues specific to Credit Suisse). As Warren Buffett once said, “it’s only when the tide goes out that you see who really is vulnerable.” The speed at which last week’s events unfolded shows us that this is difficult to anticipate in advance.
European banking stocks have taken a battering lately but share prices can be reflective of sentiment rather than the strength of balance sheets. Financial markets can be highly sensitive to every headline which means any 1% movement (that is justified) can quickly turn into a 2% move; fortunately, at the time of this writing, European market sentiment was boosted by central banks offering support as and when needed. However, there are likely to be periodic episodes of concern around banks as we adjust to higher interest rates, slowing growth and in some cases, as investors price bank-specific idiosyncrasies.
The European Banking System Is Sound, and Well-capitalised:
- Regulation and stress tests: European banks have been subject to much stricter liquidity rules since the 2008 Global Financial Crisis (GFC). In particular, the ‘Basel III’ requirement introduced minimum capital requirements, and holdings of liquid assets aimed to strengthen bank capital requirements to deal with unexpected losses.
- European banks’ government bond holdings are much lower than those of U.S. Banks: According to Bloomberg Intelligence, European banks have €1.6 trillion ($1.7 trillion) of government bonds on their balance sheets, this accounts for less than 10% of all assets for most large European banks. This contrasts with U.S. banks, where securities (largely Treasuries or GSE-sponsored) comprise around 20% of total assets.
- European banks have a buffer to absorb any immediate need for liquidity: With 16% of European banks’ assets held in cash with various central banks, this provides flexibility to react to any immediate need for liquidity. This is on par with large U.S. banks—those with over $250 billion in assets—who also have 14% of assets in cash, while quasi-regional, regional and community banks in the U.S. have less cash on hand. It may be important to note here that the European banking system is not comprised of thousands of small community banks like it is in the U.S. The number of small banking institutions has been declining as a result of large-scale mergers; smaller banks make up approximately 18% of total euro area banking assets and are concentrated in a limited number of countries (Germany, Italy, Luxembourg and Austria). Rather, there are several major banks in Europe which provide ample information about the health of the broader banking sector.
- European banks’ funding is diversified: Around 60% of European banks’ assets were made up of loans to retail and commercial customers, followed by cash balances, which make up 16% of assets, and debt securities, which comprise 12%.
#2 How are Central Banks Trying to Avert a Banking Crisis?
In response to the COVID-19 pandemic, six central banks—the Bank of England, Bank of Japan, Bank of Canada, the European Central Bank (ECB), the Federal Reserve and the Swiss National Bank—came together to announce a mechanism referred to as a ‘swap line,’ which is essentially an agreement between two central banks to exchange currencies. This program was recently reinstituted and will remain in place until the end of April 2023, with the Federal Reserve now offering daily currency swaps, rather than weekly, enhancing the provision of liquidity of U.S. dollars to the global economy. This allows a central bank to acquire foreign currency liquidity from the Federal Reserve so they are able to provide this to domestic commercial banks. This mechanism provides liquidity quickly to mitigate stresses on the supply of credit by maintaining the flow. This is particularly important for some European banks that have borrowed in dollars to finance their dollar-denominated transactions. As banks can only borrow from their domestic central bank, these swap lines will mean central banks are able to provide liquidity in their own currency as well as foreign currency, ensuring borrowers are able to repay their loans during times of financial stress.
