Klaas Knot: Mamma Mia, here we go again? Lessons from Silikon
Valley Bank and Credit Suisse
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi High-level
Seminar 2023, Stockholm, 28 April 2023.
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Hello everyone.
Yesterday was King's Day in the Netherlands. The day we celebrate the birthday of our
king. Having a monarchy is one of the great many things the Dutch and the Swedes
have in common.
Our King's Day is a national holiday with flea markets on every square, music and beer
in the high streets, and the entire country dressed up in orange to celebrate.
And every year I think to myself: "Mamma Mia, here we go again."
This thought also crossed my mind a few weeks ago, when the most recent episode of
market turmoil started - with the failure of Silicon Valley Bank and the fall of Credit
Suisse.
But are we actually 'going again'?
Alfred Nobel provides some wisdom to answer this question. He said: "One can state,
without exaggeration, that the observation of and the search for similarities and
differences are the basis of all human knowledge."
In saying this, he captured exactly what we need to do in case of turmoil, in case of a
new shock to our financial system.
Of course, every shock is unique. But often, there are similarities. And often, there are
differences with previous shocks. And it is up to us to distinguish between them. To
draw on lessons learned for what is similar. And to look for new lessons for what is
different.
We have learned a lot from previous shocks. They allowed us to identify vulnerabilities
in our financial system. And we have been able to strengthen our resilience and stability
as a result.
So far, no shock has been the Waterloo of our global financial system. But we need to
remain vigilant. We need to remain diligent, in mapping, measuring and monitoring
vulnerabilities. Old and new.
So let's put the super trouper on the most recent episode of market turmoil, and take a
closer look at what happened, what vulnerabilities were exposed, and what lessons we
can learn from similarities and differences with the past.
Roughly a month ago, on the other side of the Atlantic, Silicon Valley Bank failed. The
reason for this was a classic bank run. Similar to bank runs in the past. Different in that
this bank run was a direct consequence of SVB's specific business model. One that
created a maturity mismatch: the interest rate on assets was fixed for longer than the
interest rate on liabilities. On top of that, SVB made little use of interest rate derivatives
to hedge this risk. The name of the game was serious risk mismanagement.
However, this only became apparent once interest rates started rising. When this
happened, SVB's interest expenditure rose faster than its interest income. As a result,
net interest income fell and continued to fall. This was reinforced by the migration from
non-interest bearing deposits - on current accounts - to interest bearing deposits - on
the savings accounts and fixed-term deposits.
When account holders got wind of the bank's weaker position, and the gimme, gimme,
gimme- chant went viral on social media, a rapid outflow of savings followed. But due to
the higher interest rates, the assets SVB had to sell to absorb this outflow of liquidity,
mostly bonds, had lost value. Eventually, failure became inevitable.
Most of you know this, of course. But why didn't we see it coming?
The short answer is: money, money, money- it's so funny. The longer answer has to do
with risk mismanagement.
SVB's 2021 annual report shows that a 2 percent interest rate hike would have led to a
35.3 percent decrease in capital by the end of 2021. If the Basel interest rate risk
standards had been in place, this would have set off a series of alarm bells. Because,
according to these risk standards, this position should not exceed 15 percent of capital.
And if it were to exceed 15 percent, the financial supervisor should intervene.
But the Basel interest rate risk standards were not in place. So, it's not the case that the
supervisor didn't hear the alarm bells. It's not that the alarm bells were quiet. It's that the
alarm bells simply weren't ring, ring, ringing.
So what can we learn from this?
First and foremost - this case reaffirms that strong regulation makes for strong banks.
The failure of SVB was a shock to the financial system. And shocks are, by nature, hard
to predict. We can't change that. So we need to deal with it. And to deal with it, we need
strong and consistent regulatory frameworks. Frameworks that strengthen capital ratios
and risk management. Frameworks that mitigate the potential impact of vulnerabilities.
We learned this from the Global Financial Crisis in 2008. And today, we can reaffirm the
importance of the Basel Committee reform package. But there is a difference between
designing the necessary tools to address vulnerabilities and implementing those tools.
So, once again, I call for a quick and faithful implementation of the final Basel III
standards, with minimal and restricted transitional arrangements or exceptions. This is
needed in order to strengthen the stability of the global financial system.
What else can we learn from the SVB failure?
SVB was a relatively small bank in the US, working mainly with tech companies. But
when it comes to buffers, the size of the institution is irrelevant. Every bank, whatever
the size, whatever the scope, whatever the geographic location, should maintain strong
buffers.
Because a second lesson we have now learned, is that even a bank that was not
considered to be a systemic bank, could still cause a lot of stress in the financial
markets. Stress that could possibly have been avoided with sufficient buffers. Stress
that, knowing me, knowing you, surely got us thinking about what we can do to improve
our current policies further.
And this brings me to my third reflection in the aftermath of SVB - or rather a few
questions that might serve as food for thought.
For starters, we need to make sure that our policies are up to date - and I mean that
quite literally. Are our policies in sync with today's society? A society that, for a large
part, is characterised by digitalisation and social media. A society in which, precisely
because of this, liquidity risk seems to have become more acute.
Indeed, it cannot be denied that the speed at which deposits were withdrawn from SVB
was much faster than expected - much faster than LCR calculations take into account.
And so, should LCR be calibrated differently? And/or do we need to better stress test it?
Also - are there shortcomings in the way we look at interest rate risk? Should
supervisors consider more frequently, and for each individual bank, whether additional
Pillar 2 requirements are necessary, based on the bank's risk profile?
And finally, should unrealised losses - that is the difference between market and book
value for bonds which are held to maturity on banks' balance sheets - should those
unrealised losses be better reflected in the capitalisation of banks? And should we look
at how instruments, that are not marked to market daily, are reflected in liquidity buffers?
I don't have an answer to these questions. But I do think they should be addressed. So
that we can learn everything there is to learn from what happened at SVB.
And of course, not only what happened at SVB. Because the problems at SVB soon led
the financial market to look at other banks - banks with the same combination of
vulnerabilities, like First Republic.
These market concerns also found their way across the Atlantic, to this side, to Credit
Suisse, a bank that has suffered from a series of mismanagement problems in recent
years, and that experienced previous outflows of deposits at the end of 2022.
Here, too, we witnessed a rapid succession of events. It took, almost literally, only one
tweet to lead to the downfall of Credit Suisse. Because, once an alleged S.O.S. was on
the wire, additional deposit outflows quickly followed, Credit Suisse's share price fell,
and its CDS spread spiked. In the end, the Swiss National Bank provided additional
liquidity assistance, and Credit Suisse was sold to UBS.
FINMA, the Swiss supervisor, used a supervisory, and not a resolution power, to enable
this sale - and it came with a write-down of Credit Suisse's AT1 securities.
Although the possibility of such a principal write-down was included in the relevant AT1
prospectuses and mentioned on the bank's Investor Relations page, although investors
were clearly informed that extraordinary public support could lead to such a write-down,
and that AT1 holders may suffer losses before equity holders, and although the
coupons paid on the AT1-security well exceeded the RoE-target Credit Suisse had
communicated to its investors, FINMA's decision still took investors by surprise.
This should encourage regulators to reflect on the role and functioning of AT1
instruments in determining the capital position of banks.
But let's go back a step, and ask: why not use resolution? Or, with Alfred Nobel in mind,
what similarities or differences with previous cases led to this strategy?
In the aftermath of the Global Financial Crisis, resolution frameworks, based on the
FSB's Key Attributes, were established. Just like cross-border cooperation between
national regulators.
The past has witnessed several cases where such a resolution framework has proven
to be an effective safeguard for both depositors and financial stability. But at the same
time, we haven't had many bank failures since the Attributes were published. Which, in
a sense, makes every new case all the more different. And so, it makes it all the more
important to draw lessons from this specific case.
One lesson for sure is that it is essential to prepare more than one resolution strategy.
Different circumstances require different strategies. So we need flexibility. This
becomes all the more important in case of a liquidity crisis - when a bail-in can help to
restore investor and depositor confidence by strengthening the solvency of the bank,
but can't generate additional liquidity.
What Credit Suisse has taught us, is that we need to further explore resolution
strategies that are better able to stabilise a bank's liquidity position.
Taking Alfred Nobel's advice, and observing and searching for differences and
similarities, I can say that, today, we are in a very different situation compared to 2008.
European banks have improved their capital positions and there is a structural change
in the interest rate environment. And this is, in principle, good news for a bank's
business model. The challenges of an artificially flat yield curve, negative interest rates,
and fierce yield competition, have finally eased.
But there are also similarities. Today, too, risks are lurking around the corner and there
are numerous vulnerabilities. Risks related to funding costs and interest rate sensitivity,
or credit-related risks. And vulnerabilities related to high levels of debt in many corners
of our economy, or hidden leverage along with liquidity mismatches in the non-bank
sector.
This means that we need to remain vigilant. Supervisors, obviously. But also the
banking sector itself - making sure their capital positions, risk management and
governance strengthen their resilience in sentiment-driven markets.
So, yesterday was the Dutch King's birthday. And if I am not mistaken, two days from
now, on April 30th, His Majesty King Carl Gustaf will celebrate his birthday. I'm sure that
in between there must be some room for a Dancing Queen. Congratulations in advance
to all Swedes here today.
Walpurgis Night is also celebrated in Sweden on April 30th. The night of the bonfire. A
celebration of spring, new life and a brighter future.
Well, if we keep learning from the past, from our experiences with shocks and
challenges - if we, like Alfred Nobel said, keep searching for similarities and differences
to expand our knowledge, then I am sure we are heading, indeed, towards a brighter
future.
Thank you.