Posted: 29 / 03 / 2023

Article by: Jon Fisher, Head of Wealth

With the financial markets experiencing volatility at present, given the challenges in the banking sector, we provide some insights into the underlying causes and the potential impact on the markets in general.

Please note: Markets are highly volatile, with information changing rapidly, so please bear with us if comments appear to already be out of date.


  • Stress in the banking system in both Europe and the US is being caused by a variety of different reasons, however, in banking, confidence is key and when it disappears, it’s difficult to get it back.
  • Credit Suisse was seen as a systemically important financial institution and therefore its failure will cause market turbulence.
  • The specific treatment of certain bond holders and their associated losses has caused surprise around the world, which is forcing investors to reappraise bank financing.
  • The portfolios are highly diversified and are broadly index weighted on banks.
  • We do not see reason to make any specific changes to the portfolios at the present time.


During March there have been a few events within the global banking system, particularly in US regional banks and the Swiss banking system, that have garnered considerable attention by the financial press.

These are:

  • The liquidation of Silvergate Bank, a Californian former Savings and Loans Association (Savings and Loans Associations are similar to Building Societies in the UK), that pivoted to providing banking services to cryptocurrency users. It closed following the collapse of cryptocurrencies in 2022, which contributed to the bankruptcy of FTX, a major crypto exchange.
  • The collapse of Silicon Valley Bank (SVB), a Californian bank that had a niche in providing banking services to technology companies and entrepreneurs.
    • Following a period of extremely high growth in recent years, the rise in interest rates and an inherent mismatch between the maturity profiles of the assets and liabilities caused a wave of fear that banks’ assets were declining in value quicker than the liabilities. This led to a bank run, which is unlike bank runs of the past given the digital nature of banking now, which allows the movement of money much more quickly than historically.
    • The bank’s assets being below the $250 billion threshold also meant it operated under much lighter regulatory scrutiny (including absence of stringent risk management and stress testing) compared to large US banks.
  • The collapse of Signature Bank, a New York bank, that like Silvergate provided services to users of cryptocurrencies.
    • The rapid decline in cryptocurrencies forced depositors to withdraw en masse. This prompted the bank to seek alternative sources of funding, which, given the wider context of the above, proved difficult.
    • Interestingly, Signature Bank’s solvency was never in doubt however, as with SVB, modern-day digital banking meant a run on the bank was at such pace that it was closed by the regulator. The assets of the bank have since been purchased by New York Community Bank.
  • First Republic, a supplier of banking services to very wealthy individuals. Once again, First Republic is solvent, but a downgrade from a rating agency highlighting that its very wealthy clients are not adequately insured in the event of a failure led to a number of these clients withdrawing their deposits.
    • As of March 20th, First Republic has sufficient funding to continue and is solvent following the deposit of $30 billion from a consortium of the eleven largest banks in the US.
  • The failure and purchase of Credit Suisse by UBS. Credit Suisse had one of the weakest balance sheets amongst the so-called systemically important banks (the banks considered ‘too big to fail’).
    • Since the announcement of the three-year restructuring plan and the capital raise, there have been a number of negative news stories; a probe into the claim by the Chairman (Lehmann) that outflows had ceased; a FINMA report highlighting a breach of supervisory obligations in relation to Greensill; a technical delay to the release of their FY 2022 results driven by the SEC; and the recent statement around ‘material weakness in our internal control over financial reporting’ in relation to 2021 and 2022.
    • Additionally, and not unlike some of the US regional banks, Credit Suisse has seen a considerable contraction in its deposit base over the last 18 months as interest rates rose and deposit holders sought better returns elsewhere.
    • The bank runs in the regional US banks mentioned above focused attention on Credit Suisse and caused a sharp decline in their share price. Eventually, this led to the acquisition by Switzerland’s largest bank, UBS.
  • Unusually, holders of Credit Suisse equity have received a small amount of UBS equity, however holders of the most subordinated debt (referred to as Additional Tier 1 or AT1) have been ‘bailed in’, a term that effectively means written down to zero. However meagre the compensation received by the holders of Credit Suisse equity; it is unprecedented that they should receive anything at all in the event of a bail in of AT1 bonds.

The banking system

Banking works on confidence. At no time can even a very conservatively managed bank satisfy all of its depositors in the event of mass withdrawals.

The banking system in essence is a mechanism for allowing those without capital, who need it, to source it from those with capital who don’t need it right now.

A bank takes in deposits from those with excess capital and loans it to those who are capital deficient. Typically, deposits are either on demand or can be redeemed in relatively short order. Loans are often made for much longer periods of time and cannot be redeemed just because a bank needs the money i.e., if you have 20-year mortgage, it would make life very difficult if the bank from which you borrowed were able to demand repayment just to satisfy some withdrawals.

Consequently, there exists a plethora of regulation designed to ensure a continuity of service for both borrower and lender. Occasionally however, confidence will ebb from certain banks, which will require some form of third-party intervention. This can take several forms including obtaining funding from other banks (the interbank market); from the central bank (the so-called lender of last resort, so named because of the punitive rate of interest and the fact that if a bank can’t obtain funding elsewhere, cheaper, the central bank stands ready); acquisition and recapitalisation by a larger competitor; or, in extremis, a state bail out where rather than just depositing money with the floundering bank, it is bought and recapitalised with new equity.

Ultimately, regulation in banking exists to promote stability rather than competition since problems can become systemic if left unchecked – a painful lesson learned during the 2008 Great Financial Crisis.

Market reaction

There are two interlinked events in progress; the failure through bank runs on several US regional banks (a term used in the US for smaller banks) and the unusual actions by the Swiss regulator to partially favour equity holders over debt holders.

Ranking equity higher than debt may have further ramifications but equally could be seen as an odd exception driven by Swiss law that is somewhat at odds with Europe.

In the case of the US regional banks, it remains a possibility that there could be further bank runs, as depositors have the right to remove their money from a bank at very short notice. The key to staving off this possibility is to ensure that depositors remain confident in the strength of the banks in which they hold cash.

In the US, there is a Federal Deposit Insurance Corporation (FDIC), which provides a federal guarantee that any deposit up to $250,000 held by a single entity is insured in the event of a failure of a US-regulated bank. It is notable that all of the regional bank failures in the US have occurred in banks where the average depositor has considerably more than this amount e.g., the average depositor in SVB has c. $2.4 million and is thus only fractionally insured by the FDIC guarantee.

This is very unlike 2008 since, at present, large well-capitalised banks are becoming the beneficiary of these flights of deposits away from the regional banks as large depositors seek safety in large banks, which are subject to more stringent regulations. As it stands, US banking securities, both bonds and equities, are fairly calm following a slightly fraught couple of weeks.

In the case of Credit Suisse, certain markets are justifiably unnerved by the decisions of the Swiss regulator. In bank funding there is a tiered seniority structure; at the bottom is equity holders, which in the event of a failure receive nothing. Once all the equity has been depleted, it moves to so-called junior debt (or subordinated debt) like the aforementioned AT1.

There are two main ways AT1s get written down: a mechanical trigger where AT1 gets converted when capital falls below a certain trigger (7% or 5.125% depending on the national regulator); or a regulatory determination that a point of non-viability has been reached (at the regulator’s discretion). Credit Suisse had a CET1 ratio of 14%, so had considerable capital. This precedes SNB’s prior statement about Credit Suisse being well-capitalised.

From there each successive seniority of funding is wiped out. At the very top of the pile is deposit holders, who are further protected by state guarantees like that in the US with the FDIC. At some point during the negotiations by UBS with the Swiss regulator (FINMA) over the weekend of 18-19 March 2023, UBS managed to convince the FINMA that the Credit Suisse AT1s, which UBS would be theoretically responsible for servicing, should be wiped out. This is not unusual given the subordinated nature of Credit Suisse AT1s, however, it is unprecedented that the Credit Suisse shareholders should receive anything.

Effectively, Credit Suisse shareholders received very little compared to the value of the balance sheet, but precedent would suggest that, however paltry, it should have been nil given the bail in of the AT1s. In essence, the holders of UBS have been given the equivalent of CHF16billion by eliminating AT1 debts whilst, simultaneously, the shareholders of Credit Suisse have been given CHF3billion for something that was logically worthless given the AT1 bail in.

By turning bank seniority on its head, the Swiss government has created a degree of turmoil in the market for both bank equity and the AT1 bonds of other banks, since investors in both have witnessed events that shouldn’t be able to occur. Banks would still need to hold adequate capital, but appetite to hold AT1s exhibiting fixed income returns and inferior protection/returns relative to equity will be reduced. A few things to note for context:

  • It seems that the prospectuses in Swiss banks’ AT1 capital allows for this eventuality. This is a provision that appears to be absent in other jurisdictions. That is not to say that other regulators couldn’t/wouldn’t do the same, however the shock in the market is largely because of a lack of awareness of this relatively esoteric point.
  • In 2017, the AT1 bonds of Banco Popular Español were wiped out when it was subsumed by Santander. In that case and in line with convention, the equity was also wiped to zero.
  • AT1 bonds exist as a buffer for the banking system to aid stability in the event of a bank failure and therefore, their wiping down to zero is a feature designed from the outset. Investors in AT1s know this and are compensated with greater rates of interest than more senior debt.
  • The ECB released a statement on March 20th, reiterating the seniority of the AT1 market over the bank equity market stating ‘common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down’.

Market impact

The watchword in banking is ‘contagion’ since the systemic nature of banking can mean that general declines in confidence lead to problems in other parts of the market.

As it stands, all US bank failures have been dealt with well and little further stress has occurred. Share prices of banks have declined fairly substantially in recent weeks, however, these too appear to have stabilised.

Interestingly, the US bank failures are driven by the same factor i.e., higher interest rates offering more attractive destinations of capital, limited FDIC insurance at $250,000 and large numbers of wealthy clients. Thus, whilst it may appear alarming that several failures have occurred concurrently, these don’t appear systemic in nature at this stage.

In Europe, share prices are also down following the acquisition of Credit Suisse given the closer proximity to Switzerland. Additionally, the surprising decision by the Swiss regulator regarding AT1s has led to some stress in the $275billion AT1 market (technically, it’s now closer to $260billion as some of it was wiped out over the weekend).

The news has caused a drop of around 9% as AT1 bondholders are questioning the seniority of their holdings. This decline in capital leads to an increase in the rate offered in the market since price is the inverse of yield and this increase should be seen as a market view on the additional return required for this new risk.