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Have you saved a nice sum in your savings account? Could the bank have given your company a loan? How safe is your money? Under what circumstances can a bank go bankrupt? An overview of the different situations in which a financial institution’s solvency may be threatened or weakened.
What are the risks of client accounts?
If a bank in Switzerland files for bankruptcy, your deposit as a customer is protected up to CHF 100,000. In other words: You can be sure of getting your first 100,000 francs back. After that, there is no guarantee for anything in excess of 100,000 francs per account.
These balances go to the bank’s bankruptcy desk and can be withdrawn by customers in the distribution of bankruptcy proceeds, but there is no certainty as to whether all of this money will be withdrawn. According to the Financial Market Authority (Finma), banks are required to consistently hold 125 percent of insured deposits in order to guarantee this protection to customers’ savings of up to CHF 100,000 per account.
There is a deposit insurance called Esisuisse, created by the banking sector that pays the additional amount in case the liquidity of the bankrupt institution is not sufficient to meet the guarantee obligation of the bank. It has a maximum of 6 billion francs, with which it can cover 60,000 accounts at 100,000 francs.
Exposure to financial markets
A bank that is not exposed to financial markets (ie, does not trade on international exchanges) is protected from a significant risk: market risk. Excessive risk-taking in equity markets is one of the biggest threats to a bank’s solvency, i.e. its ability to repay debt or recover losses.
For example, UBS’s collapse in 2008 was due to its high exposure to the U.S. subprime mortgage market, which were risky real estate loans collapsing due to rising interest rates. When “exposure” is mentioned, then UBS is talking about the amount the bank has invested in these bad securities for its own account.
Therefore, it is the amount that can be completely or partially lost. This amount is included in the assets in the balance sheet. As the value of this asset fell, losses consumed the bank’s capital and its capital (equity) was depleted to cover the loss. Swiss National Bank (SNB) bailed out UBS in 2009 by removing distressed assets from the bank’s balance sheet and managing them separately. The UBS balance sheet was cleared of toxic assets and reorganized.
credit risk
Another credit risk can threaten a bank’s solvency: its role as a creditor. There are very few banks without credit risk. But there are borrowers who are much riskier than others. For example, a bank may have lent money to a major bankrupt hedge fund, a country about to default, or a bankrupt cryptocurrency platform.
These three cases have occurred in recent years. In 2020, Credit Suisse and other banks made up to $80 billion in derivative loans to a hedge fund called Archegos to speculate on technology stocks. Banks held the securities in his name. Securities fell and the fund went bankrupt in March 2021. Goldman Sachs managed to liquidate its shares on time, but Credit Suisse lost $5.5 billion. The bank’s solvency was not seriously questioned, as it had enough capital to cover its losses, but rumors of bankruptcy had the bank churning out its customers.
Bankruptcy of European banks
After the 2010-2012 Greek debt crisis, it was feared that European banks would go bankrupt because they lent a lot of money to Athens. However, since the IMF helped Greece and the European Central Bank (ECB) stopped the hedge funds’ aggressive speculation on European banks’ securities, they had enough capital left to cover their losses. It took several years for them to re-build enough capital.
Finally, the spectacular collapse of cryptocurrency exchange FTX this year has not been fruitless for banks. At the end of January 2023, it was announced that several major financial institutions had lent money to FTX. The question of the size of the commitment remains. Institutions such as BNP Paribas, Société Générale, Goldman Sachs or Deutsche Bank may be weakened by losses, even if the danger of bankruptcy is still far away. Smaller lenders, on the other hand, had to file for bankruptcy themselves after FTX went bankrupt.
the quality of the balance sheet
What is meant by saying that a bank is weak? It’s about the strength of the balance sheet. If a bank makes a loss, it can use its capital (on its balance sheet) to cover those losses. If this capital is insufficient, solvency is at risk. A negative spiral sets in motion. Shareholders see the risk of bankruptcy and sell their bank shares. Stocks are often part of the equity that makes up a bank’s capital. The lower the value of their shares, the worse their balance sheet is capitalized.
A quality balance sheet contains solid assets. The safest category of capital is cash. After that comes bonds and stocks. Then there are permissible but less secure types of capital that can be used to meet regulatory requirements but are not as robust.
An example is CoCos, which are contingent convertible bonds. This type of capital was allowed to help European banks recapitalize after the 2010-2012 euro crisis. These are bonds that the bank issues to outside investors, which can be converted into stock if necessary to cover losses. The interest rate is high because the debt ratio is low.
Thus, by issuing CoCo, banks pay higher interest rates but pass on the credit risk to outside investors rather than assuming it themselves. Investors holding these bonds will receive a periodic coupon in return, but may receive falling bank shares in the event of a crisis and are not considered senior creditors in the event of a bank failure. Additionally, it is difficult for investors to sell these CoCos at will because the regulator may refuse to do so depending on the financial strength of the bank in question.
Off-balance sheet assets
A bank’s balance sheet is a reflection of its financial health. But you should also look at the ones that are not on the balance sheet. In other words, “off-balance sheet” assets.
These assets are often found in the footnotes and appendices of annual reports because transactions have been closed, but the bank is likely to assume responsibility. Why do you care about off-balance sheet items? Because in the event of a crisis, these assets will somehow burden the bank. Therefore, it is a hidden risk. Typically, derivatives can be recorded off-balance sheet. However, liquidity risk (rate of sale), market risk (price fluctuations), or counterparty risk (the health of the other party in the transaction) – they can pose risks that can be fatal.
For example, a bank may suddenly hold illiquid assets that cannot be sold. It was Lehman Brothers’ ignorance of its off-balance sheet obligations that caused the industry’s biggest bankruptcy. Off-balance sheet assets are better controlled today than in 2008, but they still carry great risks Finally, as a client of a Swiss bank, it is not superfluous to look at the bank’s risk to international banks, which themselves are less. responsible or have less capital.
This text was originally published on the French website Blick.ch.
Source :Blick
I’m Tim David and I work as an author for 24 Instant News, covering the Market section. With a Bachelor’s Degree in Journalism, my mission is to provide accurate, timely and insightful news coverage that helps our readers stay informed about the latest trends in the market. My writing style is focused on making complex economic topics easy to understand for everyone.
