European Central Bank rate rise and the Credit Suisse Crisis

In mid-March the European Central Bank (ECB) announced a further rate hike of 50 basis points, and has signalled that it is prepared to supply liquidity to banks if needed.

Previously, the ECB had signalled that it would be raising rates again as inflation across the EU remains above the targeted level. In February, preliminary data showed headline inflation of 8.5%, well above the central bank’s target of 2%.

London Business School’s Dr Vania Stavrakeva appeared on Bloomberg Radio’s The Tape programme to talk about banking instability in Europe and the US. The following is a record of that interview.

ECB rate rise decision

Should the ECB have paused or raised the rates by 25 basis points, Dr Stavrakeva was asked. “Given the numbers we have for inflation I think the ECB did the right thing,” said Dr Stavrakeva. “They had to establish credibility at this point – the main concern in Europe is of course to get inflation under control – I am less worried about solvency issues in Europe at this point. There are of course liquidity issues on the horizon with Credit Suisse and potentially other banks. Overall, treating this situation thus far as a liquidity rather than a solvency crisis is the right approach.”

Credit Suisse dilemma

The problem with Credit Suisse is that they could never properly regain their footing after the Global Financial Crisis, explained Dr Stavrakeva. They were unable to decide what type of bank they would be. “It is a very large bank, with the asset and wealth management divisions being major parts of the bank; however, they were not competitive. They were struggling to compete with Black Rock and Vanguard, so these dynamics are part of the structural problems the bank has experienced in recent times. The retail division of Credit Suisse which is what the Swiss regulators mostly are concerned with is ring fenced and hence pretty safe.”

Some commentators have compared the present crisis at Credit Suisse and SVB with a classic ‘bank run’, but Dr Stavrakeva said she felt that this was “not quite correct”. “The problem here is not about having deposit insurance and lack of credibility of the insurance as governments are clearly willing to support their bank deposits. It is however much more about investors waking up and realising that they can go elsewhere than banks, such as money market funds, and achieve the same liquidity and much higher rates of return.”

Overall, the banking sector will have to shrink, maintain Dr Stavrakeva. “This is because many banks will not be able to afford high interest rates given that the market valuation of their assets have fallen. The problems associated with a wider banking sector disintermediation had already started since 2008, and the difficulties related to Credit Suisse and SVB, together with the interest rates hikes, are just hastening this wider adjustment. The old bank business model is simply not sustainable in an environment where even small retail investors can open a Vanguard account overnight and receive higher safe returns.”

Favouring shareholders over bondholders

In the immediate wake of the Credit Suisse crisis the Swiss National Bank (SNB), the country’s central bank, justified the UBS-Credit Suisse megamerger. The bank had taken flak from politicians and big investors in Switzerland. SNB chairman Thomas Jordan said the deal had “put a halt to the crisis”.

“An insolvency of Credit Suisse would have had severe consequences for national and international financial stability and for the Swiss economy,” Mr Jordan said in a statement. “Taking this risk would have been irresponsible.”

He said the “extremely fragile environment” and heightened market anxiety could have “triggered a bigger financial crisis” unless the Swiss authorities had taken the course they did.

After market concerns over the decision by Swiss authorities to favour shareholders over bondholders in the rescue takeover of Credit Suisse, Dr Vania Stavrakeva unpicked the takeover by UBS and the continued wider tensions in the banking world in this interview on the Yicai Business Channel of Shanghai Media Group.

The various forms of the interview can be viewed or read as follow:

TV: https://www.yicai.com/video/101710536.html
Web: https://www.yicai.com/video/101710923.html
Article: https://www.yicai.com/news/101710680.html