What the UBS Takeover of Credit Suisse Means for the Banking Sector

After a tumultuous week in the banking sector, industry experts have been assessing the impact of recent events, including the collapse of Silicon Valley Bank and UBS's takeover of Credit Suisse. While these events caused turbulence in share prices across the banking industry, the reasons behind each bank's troubles are vastly different.

Silicon Valley Bank's Troubles

Silicon Valley Bank's client base was dominated by tech start-ups, whose deposits the bank invested in US Treasuries and similar securities. However, as the US Federal Reserve raised interest rates sharply, the value of these securities fell, causing trouble for the bank. Higher interest rates also led to funding drying up for start-ups, and these companies began to withdraw their deposits from SVB.

Credit Suisse's Decline

Credit Suisse's share price has been in decline for two years, largely due to risk management failures such as the bank's exposure to Archegos Capital Management which failed in 2021. Although the bank announced a new turnaround plan in October 2022, it was seen as insufficiently aggressive by the market. This, along with pressure around a CHF4 billion capital raise, prompted significant outflows of deposits from the bank.

UBS's Takeover of Credit Suisse

Credit Suisse's shareholders will be paid CHF3 billion in UBS stock as part of the takeover deal. Regulators persuaded UBS to make the deal to preserve financial stability, which was preferable to a disorderly implosion of Credit Suisse that could have had negative implications for the global perception of Swiss banking.

Implications for European Banks

According to Justin Bisseker, European Banks Analyst, the deal should take the risk of a disorderly implosion of Credit Suisse off the table, which is a positive development for banks. Credit Suisse was an isolated case in European banking, and there is no read-across to other banks. Bisseker emphasizes that banking is a confidence game, and it's crucial to have good regulation and prudence to ensure that depositors don't lose money, and the government doesn't have to step in.

AT1 Bonds Write-Down

Credit Suisse's CHF16 billion of additional tier 1 (AT1) bonds will be written down to zero as part of the deal. AT1 bonds are designed to take losses during a crisis, but the expectation was that equity holders would take losses before AT1 bond holders. This decision will cause some dislocation in the AT1 market, especially for riskier names in the sector.

Emerging Markets

The direct threat to emerging market (EM) banks from recent events in the US and Switzerland appears limited. However, in a downside scenario where problems in developed market banks turn into a deeper financial crisis that disrupts global capital flows, EM interest rates would remain higher for longer, weighing on growth and driving up defaults.

Wider Economic Implications

Despite concerns over contagion risk, industry experts suggest that the stresses in the real economy are minimal, with few loan defaults at present. While new borrowing has fallen and the housing market has cooled, labour markets are holding up better than expected.

While recent banking turmoil has caused turbulence in share prices across the banking sector, the situation is far less severe than the financial crisis of 2008. Confidence has been shaken, but the banking industry is much more conservative than in 2008, with higher capital and liquidity levels and better regulation. The relevant authorities must address perceived weaknesses in the system and ensure that banks maintain high levels of transparency and accountability to prevent a repeat of the events of 2008. Overall, the banking industry remains an integral part of the global economy, and measures must be taken to ensure its continued stability and growth.