analysis
Status: 03/28/2023 08:20 a.m
The Credit Suisse bailout has raised questions. Haven’t banks and government regulators learned enough from the 2008 financial crisis? Experts still see gaps in the rules.
When it comes to bank failures, there is always talk of a lack of equity. Every risk must be calculated continuously. The more risky a transaction is, the more equity the bank has to keep ready. When the risk materializes, prudent bankers can offset it by reaching into their own coffers. “That assumes that I measure the risks correctly,” says banking professor Martin Faust from the Frankfurt School of Finance and Management. Three risks arise from traditional banking.
When the market turns
First, there are market risks. A banker, for example, has made wonderful deals with well-known business partners. But suddenly the market changes – and nothing is as everyone involved once imagined.
A significant market risk for banks is the interest rate risk. The Silicon Valley Bank in the USA had bought fixed-income securities during the low-interest period. As interest rates rose, the old, low interest rates on the paper became uninteresting. This reduced the value of the paper. For the bank, this meant that key corporate values were destroyed, the bank was gone.
“In the first semester of business administration you learn: There are risks from interest rate changes,” says Faust. His colleague Thomas Heidorn adds: “American banks regularly go bankrupt because of the risk of interest rate changes. In Europe, on the other hand, nobody has failed because of such market risks for a long time. They have it under control.”
The money must be liquid
The second risk of banking is liquidity. Banks should and must place their money in the market and let it work. Therefore, they have little interest in full vaults. However, if business partners lose confidence in a bank and withdraw their deposits en masse, the bank is quickly left with empty pockets.
Economist Faust considers the liquidity risk of banks to be underestimated. Regulators still have the notion that “customers are lazy.” That is wrong today: “Investors can empty their accounts online in a short time,” says Faust. This is what happened to Credit Suisse last week. “That must have been a lot in a short time,” says Volker Brühl from the Center for Financial Studies at the University of Frankfurt.
It depends on the credit rating
Thirdly, it is about the financial reliability of those to whom the bank gives money – their “creditworthiness”, as the jargon calls it. When a borrower defaults or a company that sold securities to the bank goes bust, that’s bad. In mass business, the creditworthiness of business partners can be calculated: So many percent of private customers, for example, on average over many years, are absent due to illness, unemployment or divorce. Rating helps beyond mass business: Special service providers assess the quality of business participants based on their own research and award standardized grades.
The 2008 banking crisis began because American banks had financed private houses for years without seriously checking the creditworthiness of their customers. When houses stopped increasing in value, i.e. a market risk became apparent, the poor credit rating led to the global banking crisis. It was intensified when, shortly afterwards, government bonds from Greece and other highly indebted countries could no longer bear proper interest and lost massively in value.
The special case: government bonds
Banks that buy government bonds do not have to back them with an equity buffer. Government bonds also carry two risks: The rating – i.e. the creditworthiness of the state – can change, and the market can change if interest rates change.
But in the state finance crisis 15 years ago, it was important to save states threatened with bankruptcy. If their bonds had had to be cushioned with safety buffers, they would have become more expensive. This would have made the financing of bankrupt states even more difficult. So government bonds were spared the rule of being backed with equity when banks buy them. “It’s a construction site,” says economist Brühl from the Center for Financial Studies. “One should change that.”
“We don’t think bad enough”
Well-managed banks – especially large banks – continuously calculate their risks and control them in relation to their equity. Brühl points out that bank risks can be offset by hedging transactions. However: “Apparently that didn’t work at Silicon Valley Bank.”
In risk management and banking supervision, empirical values and future scenarios are used. “We don’t think bad enough,” says Faust. “The reality is always worse than the assumption.” On the other hand, all experts agree that business cannot function without uncertainty and a willingness to take risks.