The Curse of Credit Suisse Conjures A New Banking Reality

Europe’s lenders have tons of cash — but so did Credit Suisse.

Paul J. Davies

23 Mar 2023, 02:33 PM IST

Credit Suisse is casting a shadow over Europe

(Bloomberg Opinion) -- Credit Suisse AG’s weekend rescue by UBS AG sent European bank investors reeling at the start of this week, in fear of a rolling crisis and in shock at what just happened to an apparently sound but deeply troubled 166-year-old institution.

Yet even as the initial panic subsides and bank shares recover from their swoon, the world has changed — and not only because of Credit Suisse. European banks face a different reality than they did before the US government takeover of Silicon Valley Bank only 10 days ago. The Stoxx Europe 600 banks index is down more than 10% since then.

Funding costs are higher, loan growth will be weaker and profits lower. Banks and regulators could become more cautious about liquidity and capital, although Europe’s top regulator said on Tuesday there was no plan to block share buybacks.

The Curse of Credit Suisse Conjures A New Banking Reality

When SVB collapsed in the US, it seemed mainly an idiosyncratic event — one badly managed bank that had got itself into trouble. In hindsight, it might turn out to be an early sign of something bigger. Even though it shouldn’t happen, the risk of deposit losses and liquidity strains for other banks in the US and Europe can no longer be ignored.

Many investors and analysts say they are sure that European lenders won’t suffer any sharp deposit flight: The banks have good assets, strong balance sheets and ample liquidity. Well, the same was true of Credit Suisse. The Swiss bank had its own problems — a recent history of big losses and sensational scandals, as well as poor projections for future returns and sketchy details of how to make them. But Credit Suisse’s final crisis was a reminder that depositors and counterparties can behave in unexpected ways.

The good news is that European banks have lots of spare funds, according to the technical gauges. Take liquidity coverage ratios, which show how much cash and easily sellable bonds banks hold compared with the volume of deposits they would likely lose over 30 days in a stressed situation — aka a mini bank run. A ratio of 100% means their cash and bonds exactly match their stressed outflows. European banks had, on average, about 150% before the Covid-19 pandemic, and then jumped to nearly 175% when central banks flooded markets with extra support, according to Citigroup. That has fallen since lockdowns ended but was still above 160% late last year.

Total deposits have also continued to grow in Europe until this year, whereas in the US they started shrinking last April, which put more pressure on funding costs and liquidity.

The smudge on this picture is the looming repayment of ultra-cheap European Central Bank money handed to banks through its Targeted Long Term Refinancing Operations, or TLTROs. Funding worth €1.65 trillion ($1.78 trillion) comes due in 2023, with the largest shares owed by Italian and French banks, according to Citigroup.

But what matters is what banks did with all that extra money. Silicon Valley Bank and Silvergate Bank in the US ran into trouble because they ploughed a lot of their new depositor cash into high-quality but long-term bonds. In Europe, the major portion of extra cash that came from the TLTROs was deposited back with the ECB, where banks could earn interest in a simple, low-risk way, according to Moody’s Investors Service. Bank holdings of bonds grew by much less: They only total about 12% of total assets versus more than 30% for US commercial banks.

Banks could repay a lot of their TLTROs with cash they hold at the ECB, rather than rushing to raise funding elsewhere or selling bonds. About 16% of European banks’ assets is cash held at central banks, Moody’s says.

Still, depositors can be unpredictable, and some individual banks will be more vulnerable to flighty depositors than others. Credit Suisse did have something in common with SVB in that sense: It had a concentration of a certain sort of customer. It had lots of extremely rich clients with accounts much bigger than the 100,000-franc ($108,248) deposit insurance limit.

Rich people and companies with large deposits will be quicker to move money around or demand higher interest rates in general. And if they get fearful, they could quickly switch to bigger, safer banks. UBS saw heavy deposit inflows in the days before Credit Suisse’s rescue likely for this reason.

There have been no signs of this happening around Europe yet. Corporate deposits are already more concentrated among some of the region’s biggest banks because they provide all the other services that companies need. BNP Paribas SA for example has about 70% of its deposits from financial and non-financial companies; Societe Generale SA isn’t far behind, while both Deutsche Bank AG and UniCredit SpA have more than 50% of deposits from companies, according to Citigroup.

Deposit costs for European banks will continue to rise, putting pressure on lending margins and profits. The cost of bond funding for banks compared with normal companies has already risen sharply. In the dollar markets, the gap between the two is at its greatest since 2013, according to Deutsche Bank.

All of these are issues for bank earnings, their appetite to lend and thus ultimately for economic growth. And even though this really shouldn’t be a cause for a crisis of confidence and liquidity, these are strange times and it is hard to be sure how a series of sharp interest rate rises will drive the behavior of depositors and the wider financial system.