A solid capital base is clearly important for a bank to maintain the trust of its clients, counterparties and lenders, including depositors. At the end of 2022, Credit Suisse had a BIS Common Equity Tier 1 (CET1) capital ratio of 14.1% and a CET1 leverage ratio of 5.4%, in line with its peers and well above regulatory minimum requirements. For example, UBS had a CET1 capital and leverage ratio of 14.2% and 4.4%, respectively. Hence, the capital situation by itself will not have been the reason that depositors and lenders lost trust in the bank, withdrew money in large amounts, refrained from rolling over maturing funding and/or asked for additional collateral.
Why capital does not help
Already during 2022, Credit Suisse experienced a large decrease in funding from customer deposits, falling by CHF 160 billion from CHF 393 billion to CHF 233 billion during the year. In the first quarter of 2023, a further CHF 67 billion of customer deposits were withdrawn. Even if capital could be used to cope with funding outflows (which it cannot, as we will clarify shortly), the amount will never be sufficient to cope with outflows of such magnitude. For comparison, at the end of 2021, Credit Suisse’s CET1 capital was equal to CHF 38.5 billion.
But, as mentioned, capital does not help to cope with funding outflows. A reduction in funding (liabilities) must be either replaced with new funding from other lenders or by a corresponding reduction in assets (e.g., cash or investments), leaving the amount of capital (equity) in principle unchanged[1]. If large amounts of funding are withdrawn at the same time, as was the case for Credit Suisse in 2022, it is usually not feasible to find replacement funding quickly enough at a reasonable price. In that case, there is no alternative to reducing cash and/or selling assets[2].
In such a scenario, leverage and capital ratios may actually improve, since the available capital will then support a smaller amount of assets. This is what happened at Credit Suisse during 2022. Although the amount of CET1 capital decreased from CHF 38.5 billion to CHF 35.3 billion (-8.4%), its leverage exposure[3] decreased by 27%. Consequently, the bank’s CET1 leverage ratio improved from 4.3% to 5.4%. Risk-weighted assets (RWA) also decreased, but only by 6%, resulting in a small decrease in the CET1 capital ratio from 14.4% to 14.1%. The changes in CET1 capital, leverage exposure and RWA are depicted in Figure 1.
Figure 1: Development in CET1 capital, leverage exposure and risk-weighted assets (RWA) at Credit Suisse between end of December 2021 and end of December 2022 (amounts in CHF million). Source: Credit Suisse Annual Reports 2021 and 2022.
Cash is king
In a situation of large funding withdrawals, it is critical that the bank has a sufficiently large amount of liquid assets. At the end of 2021, Credit Suisse reported CHF 230 billion of liquid assets, consisting of cash held at central banks (CHF 144 billion) and securities[4] that could be pledged to central banks in exchange for cash (CHF 86 billion). At the end of 2022, the amount of liquid assets had decreased to just over CHF 118 billion. Hence, a substantial part of the withdrawal of deposits was met by a reduction in liquid assets. The remainder was met with cash inflows from maturing loans and other assets on the one hand, and replacement with alternative funding on the other.
Lack of sufficient liquid assets was one cause of bank problems during the financial crisis in 2007-08, resulting in extensive liquidity support by central banks. With the aim to prevent this from happening again, the final Basel III rules require banks to satisfy a liquidity coverage ratio (LCR) of at least 100%. This LCR intends to ensure that a bank has sufficient liquidity to sustain significant cash outflows over a 30-day period. The regulatory rules prescribe what cash outflow assumptions need to be made for each type of liability. For example, the FINMA rules for the calculation of the LCR (see FINMA ordinance 2015/2) prescribe that for retail deposits an outflow between 3% and 20% needs to be assumed, with the percentage depending on whether the deposit is insured by a deposit insurance scheme, whether it is on a transactional or non-transactional account, and whether it is a ‘high-value’ deposit. Other outflow assumptions apply to unsecured wholesale funding, secured funding, collateral requirements for derivatives as well as loan and liquidity commitments. The amount of available liquid assets needs to be larger than the cash outflows calculated in this way, net of contractual cash inflows from loans, reverse repos and secured lending within the next 30-day period (all weighted with prescribed percentages). In that case, the LCR exceeds 100% (it is calculated as the amount of liquid assets divided by the difference between assumed cash outflows and contractual cash inflows with prescribed weightings).
At the end of 2022, Credit Suisse had an LCR of 144%, compared to 203% at the end of 2021. Hence, the amount of liquid assets relative to the amount of assumed net cash outflow decreased substantially but remained well above 100%.
Figure 2 compares the balances of the individual liability categories that are subject to cash outflows in the LCR calculation:
- The first column depicts the actual balances at the end of December 2021.
- The second column shows what the remaining balances would be after applying the cash outflow assumptions in the LCR calculation to the December 2021 balances.
- The third column represents the actual balances at the end of December 2022.
This comparison is not fully fair as we compare the actual balances between the start and the end of the full year of 2022, whereas the assumed cash outflows in the LCR calculation relate to a 30-day period. However, Credit Suisse communicated that the largest outflows occurred during the month of October 2022, so the comparison is still instructive.
Figure 2: Comparison of balances of liability categories[5] that are subject to cash outflow assumptions in the LCR calculation: Actual balances at the end of December 2021 (first column), balances that result when applying the LCR cash outflow assumptions to the December 2021 balances (second column) and actual balances at the end of December 2022 (third column). Source: Credit Suisse Annual Reports 2021 and 2022.
In aggregate, the actual balances at the end of 2022 are higher than the balances that would result after applying the LCR cash outflow assumptions (CHF 714 billion vs CHF 633 billion, compared to CHF 872 billion at the end of 2021). However, for ‘Retail deposits and deposits from small business customers’ and ‘Unsecured wholesale funding’, the actual outflow was higher than assumed in the LCR calculation. This was more than compensated by an increase in secured wholesale funding and lower outflows in other categories than assumed in the LCR calculation.
In summary, the amount of liquid assets that Credit Suisse had were sufficient to absorb the large withdrawal of funds in October 2022 without the LCR falling below 100%. Trust then seemed to be restored, but only until a new wave of withdrawals took place in March of this year, necessitating a request for liquidity support from the Swiss National Bank (SNB). Unfortunately, the liquidity support by the SNB apparently did not suffice to save Credit Suisse.
What if worse comes to worst?
That both retail depositors and wholesale lenders lost trust in Credit Suisse and withdrew large amounts of money cannot be attributed to its capital and leverage ratios by itself, because they were well above minimum requirements and in line with – if not higher than – those of its peers. Apparently, depositors and lenders lost trust because of doubts that are not visible on a balance sheet, for example:
- Doubts whether the bank would be able to stop losses quickly enough when executing the planned strategy, after a loss of CHF 7.2 billion in 2022.
- Doubts about the management quality of the bank after incurring large losses in isolated incidents (Archegos, Greensill).
- Doubts whether provisions taken for outstanding litigation cases would cover the ultimate fines.
Once such and other material doubts arise, possibly fed by rumors in the market, a bank may end up in a negative spiral of fund withdrawals. In such a situation, it will be unclear to lenders and depositors what the actual financial situation is, even though the last reported figures may have been solid. This unclarity will accelerate further withdrawals. As the developments at Credit Suisse have shown, even a very large pool of liquid assets (for Credit Suisse at the end of 2021 more than twice the amount of net cash outflows assumed in the LCR calculation and almost one-third the size of its balance sheet) will then not be enough. Since such a lack of confidence can escalate within a matter of days, as was the case not only for Credit Suisse but for example also for the Silicon Valley Bank as well as Northern Rock in 2008, there is no time to implement a recovery or resolution plan that the bank may have prepared.
Short of implementing a sovereign-money (‘Vollgeld’) banking system, which has various drawbacks as highlighted for example by the Swiss National Bank (SNB), the only realistic solution to save a bank in such a situation is for the government and/or central bank to step in and publicly commit to providing all necessary liquidity to the bank. It is important to note that this does not have to lead to losses for the government (and therefore the tax payer) as long as the capital situation of the bank in question is adequate. For all we know, that was the case at Credit Suisse.
Footnotes
[1] Only if assets are reduced at a value that differs from the book value (e.g., investments are sold below their book value), then this difference will be reflected in the amount of capital.
[2] In the first quarter of 2023, the Swiss National Bank (SNB) supported Credit Suisse with emergency liquidity funding. As a result, short-term borrowings increased from CHF 12 billion to CHF 118 billion during the quarter. This prevented that Credit Suisse had to further reduce its cash position and/or sell assets, possibly at a loss compared to their book value.
[3] The leverage exposure is equal to the bank’s assets plus a number of regulatory adjustments related mainly to derivative financial instruments and off-balance sheet exposures.
[4] At Credit Suisse, these were mostly US and UK government bonds.
[5] The categories ‘Additional requirements’, ‘Other contractual funding obligations’ and ‘Other contingent funding obligations’ comprise mostly (contingent) off-balance sheet commitments, such as liquidity and loan commitments, guarantees and conditional collateralization requirements.
