Strategy blog: The return of bank risk?

• Credit Suisse solvency fears move into focus following SVB collapse last week
• Central bank interventions soothe fears of ongoing contagion
• Investment view unaltered: overall risk appetite is unchanged

What happened?

Risk assets have partially rebounded following a slump driven by ongoing contagion fears within the banking system. The focus has shifted from the US towards Europe, where Credit Suisse has been the focus of anxiety.

The trigger for Credit Suisse’s latest slump was its delayed annual report, which revealed weakness in its financial reporting, alongside the public decision by one of its key shareholders, Saudi National Bank, to refrain from providing any further capital.

For now, fears have been soothed by liquidity interventions by the Swiss National Bank – which has committed to provide capital to systemically important institutions (‘too big to fail’) – which echo commitments made in respect of SVB by the US Federal Reserve last week. The European Central Bank also stands ready to intervene if necessary, even as it continues to raise interest rates to tackle inflation.

Have macro risks suddenly intensified?

Analysts who suggest that we shouldn’t worry may be missing the point: after the GFC in 2008, worry is a given. It was inevitable that higher interest rates would eventually expose some cyclical cracks in financial sectors and the wider economy.

However, a full-blown financial crisis need not follow - comparisons with the European Debt Crisis in 2011 or indeed the GFC seem misplaced. The challenges faced by Credit Suisse (and SVB) are not symptomatic of the wider banking system. Credit Suisse’s issues, for example, are well known and have been brewing for several years – the bank’s seemingly permanent strategic restructuring, including asset sales, job cuts and capital raisings, and its accident-prone management, are reflected in its share price. Even before this week, it had fallen by 90% since the start of 2010, while the wider European banking sector is up by 5% (both in euro terms).

From a fundamental standpoint, as we’ve noted recently, the banking system is most likely safer now: capital and leverage ratios are far stronger than they were in 2008. That’s not to say further liquidity risks won’t emerge, but the system is much better capitalised, and the central banks have been quick to respond – undoubtedly, the experience of the GFC is a warning against delay or inaction.

Investment conclusion unaltered, for now

From a top-down perspective, this latest development refocuses cyclical risk squarely on earnings, and away from interest rates (where expectations of further tightening have tumbled, and rate cuts are once again being priced in by year-end). But the prompt central bank and regulatory interventions, together with reduced systemic risk, may prevent the episode developing into a full-blown crisis. And in the meantime, there have still been no dramatic economic signals – if anything growth appears to be turning a corner and improving, while inflation continues to (mostly) subside. Policy tightening may well slow or even pause in the short term given the implicit additional tightening of financial conditions represented by heightened banking volatility, but when the dust settles, we doubt the likely profile for rates will have altered significantly.

For now, we do not think an outright reduction in risk assets from current levels is appropriate.

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