Bank runs, bailouts, disputes over whether bondholders should be burned, it all seems so 2008. Everything seems strong and stable, until suddenly a seemingly new problem brings a bank or two crashing down. Is this time different? In some ways yes: for one thing, Ireland’s banks are not a focus of concern. And in the past decade or so, elaborate preparations have been made to enable public authorities to resolve big failing banks in a manner both more orderly and less costly to the taxpayer. The past 10 days suggest these preparations were at best only partly successful.
Credit Suisse is one of the 30 designated “globally systemically important banks”, but it has been tarnished by scandals and missteps in risk management over the past few years. It had been losing customers for months and its survival was increasingly in doubt. Managing the failure of such a large and complex bank in an orderly manner was always going to be a challenge. Its larger Swiss neighbour, UBS, has probably got a good deal over the weekend, even though it had to pay the Credit Suisse shareholders about €3 billion to take over the bank. After all, a large block of Credit Suisse’s bondholders has been wiped out and that debt won’t have to be serviced.
Actually, it is the fact that Credit Suisse shareholders got something, while these bondholders were wiped out, that caused most market turbulence on Monday. Usually bondholders will not be burned in a bankruptcy unless equity is too, but the small print in the prospectuses for these special “AT1″ bonds specifically stated that they could be written down to zero if that was needed to ensure that the bank could carry on business. That’s what these bonds were for: a kind of risk capital additional to that provided by equity shareholders. They were not at all like a bank deposit.
[ Bank share sell-off spreads to Japan as SVB collapse shakes markets ]
[ ECB ‘stands ready’ to protect financial stability in Credit Suisse crisis, says Lagarde ]
Still, in an unusual implicit criticism of the Swiss, banking authorities in the European Union and in the UK made formal statements on Monday insisting that they would never reverse the usual priority of claims in this way. Nevertheless, the prices of this kind of subordinated bank bond fell sharply in European markets as investors sought to divest themselves of an asset that now seems more hazardous than it did last week.
The other co-ordinated announcement by all the big central banks, that they would provide liquidity to banks that needed it, even in foreign currency, was clearly intended to head off risks of contagion following the fumbled rescue of Silicon Valley Bank 10 days ago.
The US authorities should have been better prepared to resolve SVB (a bigger bank than either Bank of Ireland or AIB), but, during the Trump administration, they had loosened regulation and reduced their degree of preparedness for dealing with middle-sized banks. This was a bank failing in plain sight: the supervisors should have intervened in its management months ago when it became clear it had lost an amount equivalent to its entire capital reserve by investing so much of its assets in fixed-interest, long-term bonds, making it so vulnerable to a depositor run. Now, despite the guarantee, American depositors are moving their funds away from small regional banks: that will hamper the flow of credit to small American businesses.
This time, the Irish banks are not in the crosshairs of speculators, as they were in 2008 when the consequences of their reckless fuelling of the construction and property price bubble were beginning to become evident. Yes, as with other banks across the world, the share prices of the Irish banks have fallen a bit in the past week or so, but the prices are still well above where they were last summer. After all, the exit of foreign competitors (Ulster and KBC) is a positive development for the profits of the Irish banks – though it’s not at all positive for their customers. Higher interest rates can also help bank profitability, especially since not too many of the Irish banks’ assets are invested in long-term, fixed-interest instruments.
[ Are banks on the edge of another 2008-style precipice? ]
[ ECB ready to help banks after frantic €3bn rescue of Credit Suisse by rival ]
It is likely that some of the Irish decision-makers involved in the 2008 bank guarantee are feeling somewhat vindicated by the US decision to guarantee all of SVB’s depositors. Bondholders are not being protected though, either in the US or Switzerland. It was the decision to protect them in Ireland that was most justifiably criticised, both in 2008 and again in 2011, when the European Central Bank insisted that even unguaranteed bonds of Anglo Irish Bank should be paid (though in the end the ECB made up for that by acquiescing in what turned out to be for Ireland a very favourable financing solution for the famous Anglo promissory notes).
It all seems so long ago. Fortunately, for the time being at least, we in Ireland remain spectators at a delicate period of fragility in international banking, but one that should be well within the capacity of central banks to keep under control.
Patrick Honohan was governor of the Central Bank of Ireland from 2009 to 2015