Banking crisis underlines need to tread carefully from here

About the author:

Author name:

By Andrew Tang

Job title:

Analyst - Equity Strategy

Date posted:

16 March 2023, 7:30 AM

Sectors Covered:

Equity Strategy and Quant

• Just when financial markets appeared to be calming down after the issues in the US banking sector the sell-off in European bank shares has resumed overnight (-6.9%) due to concerns about the viability of Credit Suisse. At this stage, a huge amount is unclear, but a few points are worth making.

Global significance

Credit Suisse is in principle a much bigger concern for the global economy than the regional US banks which were in the firing line last week. Admittedly, its problems were well known so they do not come as a complete shock to either investors or policymakers.

However, Credit Suisse has a much larger balance sheet than SVB (CHF530bn at end-2022) and is much more globally inter-connected, with multiple subsidiaries outside Switzerland including in the US. Credit Suisse is not just a Swiss problem but a global one.

Regulatory capital put to the test

If Credit Suisse were to fail much would depend on how orderly the resolution is. As a Global Systemically Important Bank (or GSIB) it will have a resolution plan but these plans have not been put to the test since they were introduced during the GFC.

History suggests that a quick resolution can be achieved without triggering too much contagion, provided the authorities act decisively. While regulators will be aware of this, the risk of a botched resolution will worry the markets until a solution becomes apparent.

Crisis to weigh on ECB decision

The sell-off may have implications for the ECB’s policy decision due tomorrow.

Clearly there is a strong case for the ECB to wait and see how things develop however, they have already pre-announced the plan to raise the deposit rate from 2.5% to 3.0% so how they decide to balance financial stability over inflation could be a playbook for other Central Banks to follow.

Unintended consequences

Most importantly, the problems in Credit Suisse once more raise the question of whether this is the beginning of a global crisis or just another isolated case. Credit Suisse was widely seen as the weakest link among Europe’s large banks, but it is not the only bank that has struggled with weak profitability in recent years.

Moreover, this is the third “one-off” problem in a few months, following the UK’s gilt market crisis in September and the US regional bank failures last week, so it would be premature to assume there will be no other problems coming down the road.

Summary

We have been concerned about the risk of unintended consequences from the fastest pace of interest rate increases in modern history. The impact of higher rates on the financial sector comes through with a lag and when interest rates move up so sharply it shouldn’t be a surprise if some things break.

Our Tactical Asset Allocation remains unchanged for now, underweight global equities (-5%), neutral Australian Equities, Fixed Income and holding elevated cash (+5%).

Find out more

If you would like more information, please contact your adviser or nearest Morgans office. 

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