The collapse of Silicone Valley bank and Signature Bank in the US and Credit Suisse’s emergency merger with UBS Group AG this week has shaken the world. Herd psychology is a force in the fast-moving world of financial markets. The failure of Silicon Valley Bank and Signature Bank, two much smaller regional lenders, shook investor confidence worldwide.

Credit Suisse, the giant 167-year-old European bank, Switzerland’s second-largest bank by assets, is a “global systemically important bank” (or “G-SIB”) and is very different from the two US banks. Credit Suisse is not just a Swiss problem but a global one.   

Credit Suisse operates wealth management, investment banking, and asset management in Switzerland. By 2021, it employed over 50,000 people and managed 1.6 trillion Swiss francs. With over 150 offices in around 50 countries, Credit Suisse is the private bank for many entrepreneurs, wealthy, and ultra-rich individuals and companies. Its failure is feared to cause global ripples through the entire financial system.

UBS, Switzerland’s largest bank, agreed to buy its embattled domestic rival Credit Suisse for 3 billion Swiss francs ($3.2 billion) as part of a government-backed, cut-price deal.

Switzerland is a country heavily dependent on finance for its economy. The merger of these two banks concentrates even more significant risks into one banking behemoth, UBS Group AG. Also, this event appears to have damaged Switzerland’s reputation for stability and got a tag of “a financial banana republic.”

Many say that the collapse of Credit Suisse was in the offing for a long time, owing to a series of high-profile scandals (money laundering by drug dealers) and financial losses (Archegos hedge fund scandal in 2021). When its top investor, the Saudi National Bank, said it could not provide any more financial assistance, the investor and consumer confidence was shaken, and concerns were amplified. The winding up of SVB and Signature bank heightened the scrutiny over a bank reeling under tremendous pressure.

When the financial regulator FINMA became the first to rescue a globally systemically important bank, the Swiss government and Swiss National Bank (SNB) joined in. There is a striking similarity in how bondholders faced losses in this case. AT1 bond investments worth roughly 16 billion Swiss francs will become worthless (something similar happened with Yes Bank investors three years ago)

AT1 (Additional Tier 1) bonds are a debt instrument banks issue to meet their regulatory capital requirements under Basel III, an international regulatory framework for banks. These bonds are also perpetual or contingent convertible bonds (CoCos). AT1 bonds are considered hybrid capital with debt and equity features. They are perpetual, meaning they have no maturity date. They offer higher yields than traditional bonds due to their higher risk profile.

One unique feature of AT1 bonds is that they can be converted into equity or written off if the issuer’s capital falls below a certain level, known as the trigger point. This makes them riskier than traditional bonds, as investors are exposed to the risk of a write-off or conversion to equity. Overall, AT1 bonds are complex financial instruments that require careful consideration by investors due to their unique features and risk profile.

Equity instruments are generally considered riskier than debt instruments because equity investors have no guarantee of getting their money back. However, there are cases where a debt instrument can have more risk than an equity instrument. Subordinated debt is a type of debt that ranks lower in priority than other debt in the event of bankruptcy. If the company defaults on debt, subordinated debt investors may not receive their money back. As a result, subordinated debt can be riskier than equity, which ranks higher in priority.

Convertible debt is a type of debt that can be converted into equity under certain conditions. While this feature can make the convertible debt more attractive to investors, it also introduces additional risk. Suppose the company’s stock price falls below the conversion price. In that case, the debt may not be converted, and investors may be left with a lower-value debt instrument.

High-yield or junk bonds are debt instruments rated below investment grade by credit rating agencies. These bonds offer higher yields to compensate for the increased risk of default. However, high-yield bonds can be riskier than equity in some cases, as their value can decline significantly in the event of a default or credit downgrade.

Remember, debt is not always risk-free. Make a wise risk-return tradeoff decision with the understanding that very low probability events not only can happen, but they absolutely will happen.

In this turn of events, Saudi National Bank, AT1 Bondholders, Swiss authorities, and taxpayers are all on the losing side of the deal, as markets appear to be in “seek and destroy mode.” The world is witnessing a spectacular collapse for a 166-year-old bank and the third major bank collapse in two weeks.

We don’t know when and where the markets will stop. What Fed has in store!!

All we know is advanced contingency planning is needed to manage this situation. One needs to learn to embrace uncertainity, be more flexible and adaptive. Scenario planning is vital as it helps prepare for many potential outcomes. One may discover dangers and opportunities and create solutions by visualizing alternative scenarios.

The Unknown As we know, There are known knowns. There are things we know we know. We also know There are known unknowns. That is to say; We know there are some things We do not know. But there are also unknown unknowns, The ones we don’t know We don’t know.

— Department of Defense news briefing, February 12, 2002

 Best Regards

 
Dr. Tarunika Jain Agarwal Ph.D. 

Alpha Research