Are All Banks Going Broke?

Shortly after the Fed bailed out the Silicon Valley bank depositors, Reuters reported that Credit Suisse failed:

“ZURICH, March 20 (Reuters) – Credit Suisse and UBS could benefit from more than 260 billion Swiss francs ($280 billion) in state and central bank support, a third of the country’s gross domestic product, as part of their merger to buffer Switzerland against global financial turmoil.

…. The deal,…involves…a pledge from the Swiss government to absorb up to 9 billion francs in potential losses from the takeover.”

Are all banks going broke?

Urs Vrijhof-Droese is the Managing Partner of WHVP, international asset managers. Urs, an expert in international banking is based in Zurich. I’m a WHVP client.

To their credit, they immediately sent the following update:

“Last Thursday news about the need for a government rescue of Credit Suisse was made public. And over the weekend it was announced that the other Swiss banking giant UBS will take over Credit Suisse. …. We would like to shed some light on what is going on.

…. WHVP has never used Credit Suisse as a custodian bank and has never recommended the bank to clients. Thus, none of our clients have any relations with Credit Suisse and are not affected by what is going on. …. Please have a look at our latest communication: What is happening to Credit Suisse and how does it affect You.

…. If you have any follow-up questions…please let us know.”

I accepted their offer.

DENNIS: Urs, thank you for taking some time for our reader’s benefit.

The Glass-Steagall Act compartmentalized our banking system. Community retail banks and depositors were protected by the FDIC.

Speculative investment banks did not have traditional charters, and were not backstopped by the government. Stock brokerage firms held and invested a client’s money, at the client’s discretion.

Once Glass-Steagall was repealed, there was huge consolidation, marrying investment banks and brokerage houses under one roof. Within a decade, U.S. taxpayers were bailing them out for their high-risk failures. Consolidation came at the expense of the average American.

URS, how is the Swiss system set up?

URS: In Switzerland, banks are supervised by the Financial Market Supervisory Authority, which distinguishes between different kinds of banks. The Swiss National Bank has a voice and additional standards are also set by a self-regulation organization. The wide-ranging regulatory requirements for the banks affect areas like their corporate governance, organization, and financial structure.

Banks have different sizes and business models. There are “universal banks” like Credit Suisse or UBS, regional banks and “private banks.”

The universal banks provide very diversified services, and are highly leveraged. This includes retail banking, private banking, investment banking, lending, etc. Many also have other businesses where there is a conflict of interest; for example, stock brokerage.

Private banks are generally privately owned, and the term is also used more broadly for banks specializing in wealth management tailored to high-net-worth individuals.

The private banks we work with focus primarily on wealth management, while serving as a custodian for their clients who are taken care of by independent asset managers.

They provide the environment for clients to safely hold their assets. Unlike the big banks, they are willing to forgo some higher-risk ventures or profit from other businesses. These banks serve a niche market, are not highly leveraged – valuing their clients, focusing on a trustworthy relationship with a long-time horizon – and have a high level of risk aversion.

DENNIS: Our banks no longer have any reserve requirements. If there is a run on the bank it’s up to the Fed, and possibly the taxpayer, to provide the liquidity.

Does Switzerland require banks to hold any kind of reserves?

URS: Absolutely!

The liquidity requirements differ for banks defined as a systemic or non-systemic bank. Switzerland implemented the internationally agreed capital adequacy rules of the Basel Accord.

Non-systemic banks must hold capital of at least 10.5% of the risk-weighted positions; systematic banks must have a total capital of at least 12.8%. Every bank in Switzerland must obey the capital adequacy rules.

Many private banks have much higher capital than that required by law. Some of the banks we work with exceed the required capital by as much as 14%.

DENNIS: I recall Swiss banks dropping American clients because of new, stringent SEC regulations. What do you look for in a bank to safeguard your clients?

URS: That happened in 2010, due to the reasons you mentioned.

Many were uncomfortable, particularly taking on IRA retirement money from U.S. clients, or going through the rigid process to comply with your SEC requirements.

We are very conservative/careful in selecting banks to work with. While Switzerland is one of the safest jurisdictions when it comes to wealth management, compliance with the law and the safety of the chosen custodian bank is paramount.

We look at three main criteria in a potential banking relationship:

• What is the bank’s expertise and experience when it comes to U.S. clients? Is the U.S. market important to them? Is the bank able to prepare U.S. tax statements? Is the bank’s website available in English etc.?

• WHVP reviews the balance sheet in detail to ensure that the bank has enough liquidity/solvency, avoids high risks and has good corporate governance. The CET1 Ratio (Common Equity Tier 1 Capital / Risk-Weighted Assets) is heavily scrutinized. Is the custodian bank comfortably above the legal minimum? WHVP clearly prefers family-run banks that are at least partially still owned by the founding family. We believe this represents good conditions for a long-term, stable bank management and good risk management.

• WHVP conducts personal interviews with the relevant teams and decision-makers to ensure that the business philosophy, work attitude, core values, ethics, etc. are in line with our values and those of our clients.

DENNIS: Much of our U.S. problem is our government’s outrageous deficit spending. In 2019 USA Today reported:

“Federal Reserve Chairman Jerome Powell warned lawmakers …. ‘The federal budget is on an unsustainable path, with high and rising debt. …. Over time, this outlook could restrain fiscal policymakers’ willingness or ability to support economic activity during a downturn.’”

Continuing with these huge deficits makes inflation impossible to control.

What’s the situation in the EU? I know Switzerland did not join the EU; how do they handle their government spending?

URS: Unfortunately, the EU overall is quite similar when it comes to their spending behavior. However, some European countries fare better than others.

Switzerland, as you stated, is not a member of the European Union, for which we are very thankful. I feel that is a major reason we stand out as an exception when it comes to our government debt.

In Switzerland, the government debt to GDP ratio is approximately 40%. In Germany, the government debt to GDP ratio is about 70%. The EU average is about 85%.

While the EU debt levels are high, contrast that with the approximate 130% government debt to GDP ratio in the U.S.

Current levels are one issue, the other is how the debt will develop in the future. In Switzerland we have a “debt brake,” which actually works, limiting what the government can spend. Other countries do also, but they are not as strict about it.

U. S. politicians spend to historic levels and never seem to hit the brake. Eventually, a government gets to a “point of no return” where they are swamped just paying the interest on the debt.

I feel Switzerland and the EU will fare better in the long run.

DENNIS: One final question. Paul Craig Roberts tells us, “The five banks labeled “too big to fail” have $188 trillion in derivatives. The brutal fact is that 5 US banks have risk exposure that is twice the size of the GDP of the entire world.”

I’m concerned about interest rate derivatives. Investopedia explains:

“Interest rate derivatives are often used as hedges by institutional investors, banks, (etc.)…to protect themselves against changes in market interest rates, but they can also be used to increase or refine the holder’s risk profile or to speculate on rate moves.”

Do Swiss banks get involved in these high-risk derivatives?

URS: Dennis, thanks again for the opportunity to address your readers.

The short answer is yes – with some nuances….

Banks can use derivatives for speculative reasons or for security reasons. One bank may buy a derivative, (insurance) to manage their risk, while another is taking on that risk, collecting premiums looking for a huge profit.

For example, the Silicon Valley Bank could have bought derivatives to hedge their risk against raising interest rates. They didn’t and the huge interest rate risk eventually killed them.

The big banks have different departments and businesses. One of them is the counterparty to speculative derivative trades (accepting premiums taking on the risk), usually through their investment bank. They may make a huge profit, or take huge losses depending on who was right.

Why are these big banks willing to accept such high risks even though they know the risks have the potential to cause bankruptcy? They expect the government will bail them out.

Accordingly, the banks we work with use derivatives as insurance to hedge risks, not as speculative high-risk investments.

Dennis here…

I appreciate Urs’s global insights. All banks are not going broke. Until something changes, “too big to fail” is going to cost taxpayers dearly. Keep your deposits under the FDIC limits, and hammer politicos to do their regulatory job.

On The Lighter Side

Our Phoenix weather has been very inconsistent this spring. A few warm days, lots of rain, then cooler than normal. The rain did its job, ushering in the beautiful desert flowers, we are alive with color.

I live on Daisy Mountain. When their blooms explode, it is beautiful; a thick yellow carpet sprinkled with amazing saguaro cactus pointing toward the sky.

The smaller cactus plants in the yard, spice up the neighborhoods throughout the valley.

The downside is everyone is dealing with seasonal allergies which are pretty severe. Going through a lot of Kleenex….

Last week we saw normal wintertime temperatures in the 60s. The ten-day forecast predicts some days in the high 90s. We may go from winter to hot summer very quickly. Hopefully we won’t skip spring, the 70s and 80s are some of the most beautiful times of the year.

Quote of the Week:

Tax Day is coming up.

“Elections should be held on April 16^th, the day after we pay our income taxes.

That is one of the few things that might discourage politicians from being big spenders.”

— Thomas Sowell

And Finally….

Friend Alex N. shares some clever thoughts for our enjoyment:

• The guy at the furniture store said the sofa would seat five people without any problems. I don’t think I know five people without any problems.

• Sometimes you meet someone and you know from that very first moment that you want to spend your whole life without them.

• I told my 3-year-old I saw a deer on the way to work. She asked, “How did you know he was headed to work?”

• I can’t see well enough to shop online, so I’ll just drive to the store.

• Companies are bragging about making plants taste like meat. Cattle have been doing that forever.

And my favorite:

• I’m writing a book about things I should be doing in my life. It’s an oughtobiography!

Until next time…

Dennis Miller

“Economic independence is the foundation of the only sort of freedom worth a damn.” – H. L. Mencken

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