In the last few days, a certain amount of news - and more precisely the debacles of the Silicon Valley Bank (SVB) and Crédit Suisse banks - have shaken the confidence of the public and certain investors in the health of the banks and in the stability of the Luxembourg financial centre. Despite all the rational reasons which make it difficult to imagine a return to a situation such as we experienced in 2008 and 2009, we have nevertheless seen the emergence of a crisis of confidence, notably because the American and European authorities are sending out different messages about which banks would benefit from their protection as a last resort.
Are we not witnessing the return of moral hazard? "Moral hazard" refers to the risks that someone or something becomes more inclined to take because they have reason to believe that someone will cover the costs of any damages.
What happened in the two banks is very unlikely to occur in the EU or in Luxembourg because of the regulatory and supervisory differences.
For both banks, a distinction must be made between the intrinsic situation within the banks in question and the prudential supervision context.
The American bank SvB was poorly diversified on both its assets and liabilities and its risk management system was found to be more than perfectible.
As for Credit Suisse, the internal challenges of this bank were diverse, long known and widely documented in the press.
Paradoxically, SvB's difficulties have brought to light what should be the main function of banks, namely the ability to manage risks and the transformation of maturity, currency or economic nature. This capacity was unfortunately lacking at this bank. But more generally it is wise that risk management is concentrated in one place, namely within the banks, otherwise it is savers, investors and companies that would have to manage these risks directly.
Unfortunately, you can never be sure that a problem will arise in a poorly managed bank. But in order to control and limit these risks, there is regulation and prudential supervision.
And precisely in terms of prudential supervision, it should be pointed out that small American banks are not subject to the same prudential regulations, particularly in terms of risk management, as their European counterparts. Indeed, since a 2018 decision, the Basel rules on liquidity requirements (i.e. the Liquidity Coverage Ratio and the Net Stable Funding ratio) have not been applied to banks with total assets below EUR 250 billion.
In the European Union, the same prudential rules on capital and liquidity requirements derived from the Basel standard, which have been drastically tightened since the 2008-2009 crisis, apply to all banks regardless of their size.
Credit Suisse, on the other hand, is subject to equivalent regulatory constraints, but is supervised by the Swiss supervisory authority, FINMA.
This brief analysis highlights that what happened in the two banks is very unlikely to happen in the EU or in Luxembourg because of the regulatory and supervisory differences.
Specific situation of the Luxembourg financial centre
With its four pillars - retail, private, depositary & custody and corporate banking - it is an extremely diversified financial centre in which the banks are extremely stable. The capital adequacy ratios of Luxembourg-based banks (24.25% as at 31.12.2021) are well above the required minimum (10.5%) and above the European average (18-19%).
Despite all these rational reasons which make it difficult to imagine a return to a situation such as we experienced in 2008 and 2009, we have nevertheless seen the emergence of a crisis of confidence, notably because the American and European authorities are sending out different messages about which banks would benefit from their protection as a last resort. This leads me to the following thought, are we not witnessing the return of moral hazard?
"Moral hazard" refers to the risks that someone or something becomes more inclined to take because they have reason to believe that someone will cover the costs of any damages.
In the 1980s, with the deregulation of the financial system, each actor was supposed to assume the risks taken, without relying on public support in case of loss - the opposite would have encouraged irresponsible behaviour.
However, with the crisis of 2008-2009, many institutions proved to be "too big to fail", i.e. too important to be let down without jeopardising the system. In the absence of an appropriate regulatory framework, national governments had no other choice but to nationalise failing systemic banks, thus using public money to the expense of taxpayers.
A whole regulatory arsenal was then put in place in the EU, with the objective to achieve a so-called Banking Union. The first pillar of the Banking Union is the Single Supervisory Mechanism (SSM) which placed the large systemic banks (SI - significant institutions) under the direct supervision of the ECB, with the small banks (LSI - less significant institutions) being supervised by the local supervisory authority, in this case the CSSF in Luxembourg. This was completed by a fully-fledged framework for systemic banks’ resolution under the remit of the Single Resolution Board, constituting the second pillar of the Banking Union.
In parallel, deposit guarantee schemes have also been enhanced. The Dodd-Frank Act in the USA and the Deposit Guarantee Fund in Luxembourg protect savers up to USD 250,000 and EUR 100,000 respectively, but also make it clear that the portion of accounts above these amounts are not insured. This is to limit moral hazard.
But when Silicon Valley Bank failed in March 2023, all its depositors had access to their funds, including those whose accounts exceeded the USD 250,000 limit. Considering that the depositors’ base was composed of tech and startup companies, the US authorities made an exception in order to prevent contagion on this sector of the economy. This illustrates the issue raised by writing-off fully or partially depositors (corporate or individuals) in a situation when banks’ resolution or bankruptcy occurs. Indeed, while this “bail-in” mechanism is foreseen by the EU regulatory framework, public stakeholders are mindful of potential adverse consequences on the real economy if corporates or private individuals loose part of their deposits. There is no doubt that the forthcoming revision of the European Crisis Management Framework will be the opportunity to balance theory and practice regarding this sensitive issue.
So is moral hazard back? Only time will tell.
But whatever the response to this question will and the new context that will emerge, the ABBL and its members will stay committed to promote the sustainable development of regulated, innovative and responsible banking services and to foster trust in the stability of the system.
How do we do that? First, by contributing to training and upskilling of our talents, so that they can respond to the challenges of an ever-changing environment and serve their customers reliably. But also, by working with authorities on national and European level to continuously develop a regulatory framework that improves consumer protection and ensures a well-functioning and competitive market.