newindianexpress | The UBS acquisition of Credit Suisse requires the Swiss National Bank to assume certain risks. It will provide a Swiss Franc 100 billion ($108 billion) liquidity line backed by an enigmatically titled government default guarantee, presumably in addition to the earlier credit support. The Swiss government is also providing a loss guarantee on certain assets of up to Swiss Franc 9 billion ($9.7 billion), which operates after UBS bears the first Swiss Franc 5 billion ($5.4 billion) of losses.
The state can underwrite bank liabilities including all deposits as some countries did after 2008. As US Treasury Secretary Yellen reluctantly admitted to Congress, the extension of FDIC coverage was contingent on US officials and regulators determining systemic risk as happened with SVB and Signature. Another alternative is to recapitalise banks with public money as was done after 2008 or finance the removal of distressed or toxic assets from bank books.
Socialisation of losses is politically and financially expensive.
Despite protestations to the contrary, the dismal truth is that in a major financial crisis, lenders to and owners of systemic large banks will be bailed out to some extent.
European supervisors have been critical of the US decision to break with its own standard of guaranteeing only the first $250,000 of deposits by invoking a systemic risk exception while excluding SVB as too small to be required to comply with the higher standards applicable to larger banks. There now exist voluminous manuals on handling bank collapses such as imposing losses on owners, bondholders and other unsecured creditors, including depositors with funds exceeding guarantee limit, as well as resolution plans designed to minimise the fallout from failures. Prepared by expensive consultants, they serve the essential function of satisfying regulatory checklists. Theoretically sound reforms are not consistently followed in practice. Under fire in trenches, regulators concentrate on more practical priorities.
The debate about bank regulation misses a central point. Since the 1980s, the economic system has become addicted to borrowing-funded consumption and investment. Bank credit is central to this process. Some recommendations propose a drastic reduction in bank leverage from the current 10-to-1 to a mere 3-to1. The resulting contraction would have serious implications for economic activity and asset values.
In Annie Hall, Woody Allen cannot have his brother, who thinks he is a chicken, treated by a psychiatrist because the family needs the eggs. Banking regulation flounders on the same logic.
As in all crises, commentators have reached for the 150-year-old dictum of Walter Bagehot in Lombard Street that a central bank's job is "to lend in a panic on every kind of current security, or every sort on which money is ordinarily and usually lent."
Central bankers are certainly lending, although advancing funds based on the face value of securities with much lower market values would not seem to be what the former editor of The Economist had in mind. It also ignores the final part of the statement that such actions "may not save the bank; but if it do not, nothing will save it."
Banks everywhere remain exposed. US regional banks, especially those with a high proportion of uninsured deposits, remain under pressure.
European banks, in Germany, Italy and smaller Euro-zone economies, may be susceptible because of poor profitability, lack of essential scale, questionable loan quality and the residual scar tissue from the 2011 debt crisis.
Emerging market banks' loan books face the test of an economic slowdown. There are specific sectoral concerns such as the exposure of Chinese banks to the property sector which has necessitated significant ($460 billion) state support.
Contagion may spread across a hyper-connected financial system from country to country and from smaller to larger more systematically important banks. Declining share prices and credit ratings downgrades combined with a slowdown in inter-bank transactions, as credit risk managers become increasingly cautious, will transmit stress across global markets.
For the moment, whether the third banking crisis in two decades remains contained is a matter of faith and belief. Financial markets will test policymakers' resolve in the coming days and weeks.
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