Steven Maijoor: Keeping our windshiels intact - lessons from the
recent market turmoil
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands
Bank, at the General Assembly dinner of the European Association of Co-operative
Banks (EACB), Brussels, 8 June 2023.
* * *
Good evening everyone,
Thank you for having me here. I have always known the EACB to be a constructive
player, offering helpful contributions in the field of social responsibility and giving useful
and constructive input on draft EU financial regulations. So I am happy to speak here
today at this General Assembly dinner.
In the US, there's an old saying: whenever the Fed hits the brakes, somebody goes
through the windshield. Well, the Fed has hit the brakes again. And so have the ECB
and other central banks. They've hit the brakes pretty hard. Because that's what central
banks do when inflation reaches levels not seen in forty years. And sure enough, we
have seen some windshields shatter recently, on both sides of the Atlantic. Let me
share with you my take on the past few months, focusing on what happened at Silicon
Valley Bank and Credit Suisse, the lessons we can draw from these events, and what
this means for the European banking landscape.
If somebody hits the windshield, the first obvious question to ask is: were the seatbelts
securely fastened? SVB clearly wasn't buckled up. This was a case of serious risk
mismanagement.
SVBs interest rate mismatch, whereby the interest rate on assets was fixed for longer
than the interest rate on liabilities, was not hedged with derivatives and was
inappropriately managed.
When interest rates started rising, SVB's interest expenditure grew faster than its
interest income. As a result, net interest income started falling. And it kept falling. This
was reinforced by the migration from non-interest bearing deposits - on current
accounts - to interest bearing deposits - on savings accounts and fixed-term deposits.
When account holders got wind of the bank's weakened position, there was a rapid
outflow of savings. And due to the higher interest rates, the assets SVB then had to sell
to absorb this outflow of liquidity, mostly bonds, had lost value. No airbags, no
seatbelts, and there went the first windshield.
Of course, most of you already know all of this. But why did no one see it coming?
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 dashboard warning
lights flashing red. 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, the supervisor was not
forced to intervene.
So what can we learn from this?
First and foremost - what happened at SVB reaffirms the need for strong regulations.
Regulations that strengthen capital buffers and risk management. Because these are
the airbags and safety belts of our financial system. So it will not surprise you that I am
even more convinced that we need a quick and faithful implementation of the final Basel
III standards, with minimal and restricted transitional arrangements or exceptions. In
Europe, we have implemented the Basel standards more consistently across banks of
all sizes. But let's not forget that the Basel III standards have not yet been fully
implemented in European regulation. And in fact, current proposals to do so contain
important deviations and transitional arrangements. Arrangements that, if adopted,
could lead to inadequate capital coverage of some risks for a long time. The recent
stress reminds us that this is something we should really think twice about.
What happened at SVB also underlines the need for strong, assertive supervisors. One
thing the Fed's evaluation of the SVB case makes clear is how important it is that
supervisors not only understand the risks and vulnerabilities of the entities they
supervise, but that they also make full use of the instruments in their toolboxes. Only
then can they be effective and ensure that banks fix their problems.
A second lesson we have learned from the SVB failure is that even a relatively small
bank, that was not highly connected to other banks, can still cause contagion and
spread a lot of stress in the financial system. Stress that could possibly have been
avoided with sufficient buffers and a further strengthening of current policies.
And this brings me to my third point about SVB - or rather a few questions that might
serve as food for thought.
For starters, liquidity risk seems to have increased, partly as a result of social media
and digitalisation. The speed at which deposits were withdrawn from SVB was much
faster than expected - much faster than LCR calculations take into account. Which
raises the question: should the LCR be calibrated differently? Should we assume higher
outflow rates? And do we need to improve our stress tests?
We might also ask ourselves if there are shortcomings in the way we look at interest
rate risk and the mismatches banks have on their balance sheets. In Europe, the Basel
standards for interest rate risk have been introduced through the institution-specific
Pillar 2 requirements, and they apply to all banks. The recent turmoil underlines the
importance of this regulation, as well as the need for continued vigilance. Are we sure
that the underlying assumptions for customer behaviour and deposit duration are
conservative enough in today's digital world? Banks should monitor very closely the
assumptions they make when managing interest rate risk and adjust those assumptions
if there is reason to do so.
And finally, should unrealized losses - that is the difference between market value and
the valuation based on historical cost - should those unrealized losses be better
reflected in the capitalization of banks? And should we look at how instruments that are
not marked to market daily are reflected in liquidity buffers? It would be for example
useful to tighten the use of these assets as high-quality liquid assets.
These are all valid questions that I think should be addressed. So that we can learn
everything there is to learn from what happened at SVB.
Let me now turn to this side of the Atlantic, where we had our own shattered windshield.
Shattered by Credit Suisse, a bank that had 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. Deposit outflows quickly followed, the
share price fell and the 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, came with a write-down of Credit Suisse's AT1 securities.
The bank was not bailed out. Instead capital providers contributed significantly to its
restart, exactly as intended by the new legislation after the global financial crisis. At the
same time, things did not go as smoothly as we had hoped. The decision by FINMA
took investors by surprise. Despite the fact that the possibility of such a principal
writedown had been included in the relevant AT1 prospectuses and mentioned on the bank's
Investor Relations page. And despite the fact that investors had been informed that
extraordinary public support could lead to such a write-down. To me, this shows that we
need to reflect on the role and functioning of AT1 instruments in determining the capital
position of banks.
Another lesson we can learn from both SVB and Credit Suisse is that internal controls,
risk culture and governance are root causes that may bring up other deficiencies in a
bank in a later stage. If there are several passengers pulling at the wheel as the car is
about to drive off a cliff, airbags and seatbelts aren't going to help you. So banks need
to be aware of their decision-making procedures and promote a healthy company
culture in order not to hamper effective governance and strategic steering. That's why I
firmly support that risk culture and governance are priorities in the banking supervision
by the SSM.
Looking at everything that has changed in the European banking sector since 2008, I
think we are in a different situation now. European banks have stronger capital
positions and the change in interest rate environment is in principle good news for the
banks business models. Also, European supervisors are well aware that the ongoing,
fast-paced changes in monetary policy conditions are increasing our banks' exposure to
interest rate risk. Within the SSM, we therefore started assessing interest rate risk as
early as the second half of 2021, when the first signs of inflationary pressure emerged.
And in 2022, interest rate risk was included in our supervisory priorities. So these are all
positives.
But there is absolutely no reason for complacency. Interest rates are still rising, and this
leads to risks related to funding costs and interest rate sensitivity, or credit-related risks.
And the high level of debt and interconnectedness in the system creates vulnerabilities,
as well as a large number of unknown unknowns. Not to mention the long-term
structural challenges we face, like climate change, the transition to a sustainable
economy and the ongoing digital transformation.
This means that we need to remain vigilant. In the first place, this goes for the banking
sector itself, which needs to make sure that its capital positions, risk management and
governance strengthen its resilience in a very uncertain and volatile environment. But
supervisors must also remain vigilant. As central banks hit the brakes, financial stability
risks inevitably increase. But if we make sure our airbags, seatbelts and warning lights
all work, we can hopefully keep our windshields intact.