Credit Suisse failure reveals Swiss banking’s big dirty secret
And then there was one. Over the weekend, the Swiss authorities abandoned their long-standing “two-bank policy”, mashing UBS and domestic rival Credit Suisse together in the hope of preventing a banking crisis from gathering momentum.
Credit Suisse called it a merger. UBS called it an acquisition. Plenty of people are claiming it was a “bailout” (although the Swiss financial regulator is adamant it was not).
Well, it certainly wasn’t a merger. The price of £0.67 a share is a huge discount on Friday’s close of £1.64 and means the bank’s market capitalisation fell from around £27bn to less than £2.7bn in just two years.
What’s more, around £14.1bn of Credit Suisse's bonds have been rendered worthless. Bank investors have therefore been rudely reminded that they are not in fact making a one-way bet.
On the flipside, the Swiss authorities had to put plenty of taxpayer money at risk to seal the deal.
The Swiss National Bank is providing a £88.3bn liquidity line and is guaranteeing £7.9bn of losses if UBS has to write down more than £4.4bn on a portfolio of problem assets.
However, it’s entirely possible none of that money will be needed.
The question of whether this is a bailout or not therefore won't be settled until we find out what happens next.
UBS may very well have just done the deal of the century by securing over £1.1 trillion in assets under management for the same amount it would cost to buy Greggs.
The more intriguing aspect of the crisis is why it even happened. There wasn’t, on paper at least, a whole lot wrong with Credit Suisse.
It had plenty of capital. It had plenty of liquidity (especially after the Swiss National Bank agreed a backstop). And, most importantly, there were no obvious dodgy assets burning a hole in its balance sheet.
Such nasties could emerge in the coming months. But, right now, it appears a 167-year-old financial institution was wiped out because a number of scandals and management errors had rendered it reputationally immunocompromised just as contagious worries about banks started to spread around the world following the collapse of Silicon Valley Bank in the US.
The implications of this will be profound.
It suggests such intangibles as the corporate culture, strategic direction and client relationships of the biggest banks have a material impact on financial stability. Does that mean they should be regulated by the authorities? And, if so, how?
This episode has also revealed one of Swiss banking’s dirty secrets: Swiss banks aren’t very good at banking.
The reputation of the country’s financial industry really rests on wealth management. Investment banking, in particular, requires a whole different skill set and mentality.
Both Credit Suisse and UBS acquired theirs from the US and UK rather than developing it.
The former purchased First Boston in 1996. Swiss Bank Corporation, which later became UBS, bought SG Warburg in 1995 and Dillon Read in 1997. At the time banks around the world were racing to turn themselves into full-service universal banks.
Many of the marriages were far from happy.
In the years following the financial crisis, most banks shrank in response to tougher economic conditions and regulations. But those that had been placed in “special measures” by their governments were obliged to shrink faster and further.
That was certainly true of UBS, which cuts its costs, headcount and risk-weighted assets far faster than Credit Suisse.
Just as it was picking itself off the floor, UBS was hit by a rogue trading scandal in 2011, which caused the management to grow even more disillusioned with investment banking.
Later that year, it announced the already diminished risk-weighted assets of the division would be cut in half.
Credit Suisse’s pretensions to universal banking greatness lasted another decade. But then it suffered a series of controversies and huge losses after getting caught up in two of the biggest financial scandals of recent years – the collapses of Greensill Capital and the hedge fund Archegos Capital Management.
Enough was eventually deemed to be enough.
The latest management team (there have been quite a few) was planning to spin off its investment banking arm and rebrand it as CS First Boston. UBS may now decide to just wind it down.
In theory, there are huge benefits to the universal banking model. Having retail, wholesale and investment banking under one roof creates efficiencies, reduces the cost of capital for business clients and helps turbo-charge economic growth.
However, the case against allowing potentially flighty retail and business deposits to fund longer-term and much riskier investment banking activity has been strengthened by recent events.
In a properly functioning financial system, banks should be allowed to fail. But, even with all the recovery and resolution mechanisms put in place since the financial crisis, when push comes to shove, the state steps in.
We also need to be mindful that nowadays, when rumours can put a girdle round the earth in the time it takes to push the retweet button and deposits can be withdrawn with the swipe of a finger, the risk of bank runs may be increasing.
But perhaps the most compelling argument for splitting retail and investment banking activities is that the vast majority of big universal banks are just conspicuously and consistently rubbish.
Whether that’s because they are too big to fully understand and therefore manage or the incentives are wrong doesn’t really matter. It just doesn't work.
You can count the number of well-run large universal banks on one finger: it’s JP Morgan.
Most of the others have been unable to produce a return on equity above their cost of capital over the past of twenty years. That means that, in effect, they might as well have taken their shareholders’ money and set fire to it.
Plenty will now be arguing for the reintroduction of something like the Glass-Steagall Act of 1931, which separated commercial banking from investment banking. But ultimately that may be unnecessary.
Why was it UBS buying Credit Suisse and not the other way round? Because UBS got out of investment banking faster than its former rival.
There’s a lesson in that. And bank shareholders around the world would be foolish to ignore it.