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E-MailLucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School.
Related research from the Program on Corporate Governance includes Self-Fulfilling Credit Market Freezes by Lucian Bebchuk and Itay Goldstein.
Credit Suisse, one of the world’s largest 30 banks with assets exceeding $500 billion, melted down earlier this month. How this collapse quickly unfolded raises serious questions about the regulatory actions preceding it and the future of banking regulation.
On the afternoon of Wednesday March 15, the Swiss National Bank (SNB) and the Swiss banking regulator (FINMA) issued a joint statement expressing unambiguous confidence about the stability of Credit Suisse. SNB and FINMA unequivocally stated that Credit Suisse “meets the higher capital and liquidity requirements applicable to systemically important banks.” SNB also pledged to provide CS with liquidity if necessary.
Four days later, however, with CS facing significant withdrawals, SNB chose not to provide additional liquidity but instead forced CS to sell itself on Sunday March 19 to UBS for less than half of the market capitalization CS had just several days ago. And whereas shareholders at least got some value, the Swiss authorities chose to wipe out completely CS bondholders owed about $17 billion.
The actions that Swiss authorities took on Wednesday and on Sunday cannot be both right. If the SNB’s Wednesday March 15 statement about Credit Suisse’s situation was justified, then the assets of CS substantially exceeded its liabilities to enable CS to have the capital of dozens of billions of dollars that was required for a systematically important bank to be well-capitalized. If this were indeed the case, then SNB’s subsequent choices were highly problematic.
With access to private bank information, SNB and FINMA were able on Wednesday to estimate the value of the CS’s assets better than the market was able to do. Although deposit withdrawals accumulated between Wednesday and the end of the week, the value of the assets on CS’s balance sheet presumably did not significantly change. Thus, if SNB’s Wednesday statement was correct, then SNB could have acted subsequently provided CS all necessary liquidity in accordance with its Wednesday pledge. With the value of the assets exceeding those of liability by a substantial amount, such provision of liquidity would have represented a classic lender-of-last resort move that, given the significant capital cushion of CS, would not have been expected to come at the expense of taxpayers.
Moreover, if CS met capital requirements as the Swiss authorities stated on Wednesday, then SNB’s subsequently forcing a low-price sale of CS wronged the shareholders of CS. Such taking could not be justified by SNB’s viewing it as a transfer from shareholders in one major Swiss bank to another. Furthermore, CS bondholders whose securities were selected to be wiped out lost even a higher fraction of value than CS shareholders, and this is disconcerting given that these bondholders ranked higher than shareholders in the priorities ladder.
Conversely, if the SNB’s choice on Sunday March 19 to force a sale of CS for a small amount was justified, then the assets of CS could not have significantly exceed liabilities. In this case, however, SNB’s unequivocal statement on Wednesday about CS’s adequate capitalization was troubling. Indeed, to the extent that the statement did not reflect a genuine confidence regarding capitalization levels, its consequences could affect the credibility not only of the SNB but also of central banks worldwide.
Could it be that the SNB’s actions on Wednesday March 15 and Sunday March 19 were both justified? For this to be the case, SNB had to be right in concluding on Wednesday that CS was well-capitalized but also to conclude on Sunday that, due to subsequent rapid deterioration, CS could no longer be saved. On this view, although the value of the bank’s assets did not change much between Wednesday and Sunday, by Sunday the growing panic among depositors made it impossible to stop an expected “run on the bank.”
On the traditional view of banking, if a bank is well-capitalized, then any panic by depositors would create a problem that would be only temporary and could be effectively addressed by the central bank’s providing sufficient liquidity as a lender-of-last-resort. This view might have been reflected in the SNB’s Wednesday pledge to provide liquidity if necessary to a bank that it viewed as well-capitalized. However, when SNB chose on Sunday to capitulate and push CS shareholders and bondholders under the bus, SNB might have lost confidence that any run on a bank that is adequately capitalized can be effectively addressed.
If this were indeed the case, SNB’s reversal of course could be understandable. But even though the events of the past week in such a case would not provide a basis for blaming Swiss authorities, they would raise broader concerns about our banking systems. The concerns would be that systematically important banks might be vulnerable to bank runs due to panics and self-fulfilling fears even when such banks fully satisfy the significant regulatory requirements arising from the last crisis. As we now watch unfolding dramas at other banks, we should also think about these broader questions.
