30 Mar 2023 5 min read

Banking stress: is Credit Suisse an outlier?

By Dan Lustig , Amélie Chowna

As we move on from the Swiss bank's shotgun marriage with peer UBS, we assess the systemic vulnerability of the European banking sector.

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As the dust settles from the dramatic forced acquisition of Credit Suisse by UBS, we can now take stock of some of the consequences.

The implosion of the 167-year-old lender caused volatility in banks’ bonds and has added to the dilemmas facing central bank policymakers – but was Credit Suisse (CS) an outlier? Could its issues be replicated across the European banking sector, as the rising interest rate environment teases out vulnerabilities in the system?


Credit Suisse in context

At the end of Q4 2022, CS had a common equity tier 1 (CET1) ratio of just over 14%[1], substantially more than some systemically important European banks. The CET1 ratio compares a bank's capital against its risk-weighted assets to determine its ability to withstand financial distress; we can therefore conclude that CS didn’t have a solvency issue.

Asset quality appears not have been the issue either, with CS reporting a ratio of non-performing loans of only 1.3% at the end of 2022[2] – one of the lowest rates among European banks.

Meanwhile, CS’s liquidity capital ratio (LCR) of more than 150% in March appears to have been relatively middle-of-the-road by European standards. The purpose of LCR is to serve as a buffer of liquid assets to insulate against times of market stress, with the regulatory minimum 100%. This measure was introduced as part of the regulatory response to the global financial crisis; at mid-March 2023, at more than 150%, CS had a ratio substantially stronger than many of its peers.

Taken together, these factors lead us to believe systemic risk overall appears limited. From the perspective of European banks’ balance sheets, asset quality and capital positions, now seems to be an unusually ‘good’ time for a banking crisis, with the robust indicators suggesting little risk of contagion.

If CS appears not to have been exceptional by several of the key metrics of a bank’s financial health, what then lay behind its failure?


Collapsing confidence

Banking is about confidence; bank runs happen when there is an abrupt collapse in depositors’ confidence they will be able to reclaim their funds.

This has been happening as long as there have been banks; the difference today is the radically accelerated pace information travels at, even compared to 2008. CS underwent something resembling a run after a ‘Twitterstorm’ in the final quarter of 2022, losing 37% of its deposits.

At that time, its LCR troughed at 120%, but recovered to 144% by the end of 2022 and, as we have seen, 150% by March of this year.

Given subsequent events, this raises questions around the assumptions of the LCR and whether regulators will need to recalibrate it going forward. 

Additionally, once we leave the LCR behind, we start to see ways in which CS was an outlier compared to its European peers.


Profitability and insurance

In our view, CS failed due to its outlying status as a loss-making bank that was in the middle of restructuring away from investment banking, a factor that worked in combination with its large uninsured deposit base to make the bank uniquely vulnerable to a run-like event.

If, as we expect, a recession develops this year in both the US and Europe, investors are likely to turn their focus from funding and liquidity ratios to asset quality and banks’ strategies for profitability.

However, we think Europe’s globally systemically important banks are much better placed today than before the global financial crisis to weather this challenging macroeconomic outlook.


Options for regulators

While European banks appear in good health, recent event have nevertheless provoked understandable market jitters.

In our view, there are a number of options available to regulators if they are to shore up investor confidence.

These include mandating enhanced disclosure requirements around the quality of European banks’ deposits and enacting a ban on the short selling of European bank equity assets and/or ‘naked’ credit default swaps. Central banks could also act as lenders of last resort by extending liquidity lines and reducing collateral requirements; many of these measures were previously employed during the European sovereign debt crisis of the early 2010s.

More speculatively, regulators could also lift the threshold for deposit guarantees, which could make large depositors less ‘flighty’, or allow banks to operate with lower minimum requirements for how much AT1 debt they can hold.


Investment implications

Our Active Fixed Income team remains overweight in European banks for a number of reasons.

Bonds from issuers in the financial sector – including European banks – have substantially underperformed similarly rated bonds from non-financial issuers and in our view offer attractive valuations. We put strong emphasis on credit analysis and focus on the most senior parts of the capital structure (i.e. senior preferred debt), especially in smaller banks.

Accordingly, we are overweight senior debt and underweight subordinated bank debt – despite the attractive price point of the latter, as higher seniority provides more cushioning in case of a resolution.

In our view, European banks face the current challenging macroeconomic backdrop in strong positions from a fundamental perspective thanks to improved capital ratios, asset quality and liquidity positions resulting from action by the European regulator after the global financial crisis.

With higher interest rates in Europe, interest rate margins are expected to improve, thus increasing European banks’ profitability, which could serve as their first defence against losses.

More broadly, at LGIM we are underweight risk assets in general in part because we believe the stress in the banking sector makes a recession in the second half of this year more probable, as this makes banks likely to less lend money to the real economy.

We plan on holding this stance until there’s greater clarity on the macro outlook – and on the ability of central bankers to balance the competing objectives of ensuring financial stability while tackling still-elevated inflation.


For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.​


[1] Source: Credit Suisse

[2] Source: Credit Suisse

Dan Lustig

Senior Credit Analyst

Dan is a senior credit analyst covering financial institutions in the Pan-European Credit Research team. Dan joined LGIM in August 2011 after spending over five years as Head of Investment Research at Mitsubishi UFJ Trust International where he focused on European and US financials and hybrid instruments. Prior to that, Dan was an equity fund manager at Lloyds TSB Private Banking focusing on insurance, telecoms, utilities and industrial sectors. His previous professional experience includes roles in equity research and engineering. Dan holds an MBA from Rotterdam School of Management (Erasmus University) and a BSc in Computer Science, Statistics and Operation Research from Tel-Aviv University. He is a CFA Charterholder.

Dan Lustig

Amélie Chowna

Fixed Income Investment Specialist

Amélie is a Fixed Income Investment Specialist within the Global Fixed Income Team, covering Global Credit and Absolute Return Portfolios. Prior to this, she was a Portfolio Manager for the Global Bond Strategies team, which she joined in 2014 as a Quantitative Analyst. She joined LGIM in 2011 from AXA IM and held a variety of roles within LGIM before joining the Global Fixed Income team. Amelie graduated from ESSEC Business School and holds an MBA. She has been a CFA charterholder since 2015.

Amélie Chowna