The three weeks after March 10, 2023 saw significant volatility in the U.S. and European banking sectors. Two U.S. regional banks failed (Silicon Valley Bank [SVB] and Signature Bank), one of the 30 global systemically important banks, Credit Suisse, lost its independence after a government-facilitated takeover by UBS, and market and depositor confidence in parts of the sector evaporated. Following the strong policy response and a letup in the jittery market sentiment, volatility has since eased moderately. Nevertheless, this period saw the most acute stress for U.S. banks since the global financial crisis (GFC) in 2008/2009 and in Europe since the euro sovereign debt crisis of 2011/2012. And although we believe the availability of the Fed's emergency lending facility has helped to reduce widespread contagion risk stemming from SVB's failure, pressure could rebuild, particularly on banks whose relative vulnerabilities in earnings, risk management, or funding access are exposed by tightening monetary policy. Given these stress events' relative rarity, they carry significant informational value for bank analysis and ratings, as they inform us on how the authorities may react in future. We focus here on observations related to the design and application of national crisis management frameworks. For commentary on other analytical topics, see the "Related Research" section.

Since the GFC, policymakers and banks have refined their crisis management arsenal with a view to deal with bank failures in a more predictable and less costly way for taxpayers. These tools include the preparation of recovery and resolution plans for many systemic banks, and the broadening of monetary policy facilities to address bank liquidity shortages. Political authorities and central banks also remained well-aware of the need to tackle financial stability concerns as early as possible, to avoid the negative doom loop between financial and economic crises.

With their reactions to recent events, the U.S. and European authorities have illustrated how supervisory preparations and political dimensions can interact with the specifics of the stress scenario to yield the authorities' preferred combination of crisis management tools. While the authorities' actions have undeniably helped to mitigate financial stability risks in the short term, we observe differing conclusions among market participants on longer term implications, not least the plausibility of using resolution to address the largest systemic banks if they were to fail.

We outline below 11 observations from these events, many of which reconfirm our views on the interventions we expected would be taken in times of bank stress. Overall, we consider that bank crisis management plans do not impede flexibility. Authorities have shown their willingness to respond to the specific circumstances of each crisis in a pragmatic and coordinated manner to achieve the overarching goal of protecting financial stability--in a manner that is lawful in that country given the prevailing circumstances. Therefore, while authorities may wish to manage stakeholder expectations with time-consistent and predictable reactions to events, we are careful not to extrapolate conclusions from one jurisdiction or a specific stress situation and apply them directly to hypothetical future scenarios.

Faced with a failing systemic bank, we have observed that authorities will typically prefer to facilitate its sale to a larger, more stable player, should that be possible--not least because this is likely to carry fewer consequences for other banks and, depending on the terms, could recoup significant value for bank creditors and, potentially, shareholders, and minimize losses for the deposit insurance scheme. In our view, such a sale will be most likely when the bank failure is triggered by a funding/liquidity crisis, rather than a solvency crisis, and contingent liabilities are manageable. However, the authorities' ability to execute a transaction like this for the largest systemic banks is far from certain. So they often plan heavily for an alternative path, which means resolution in Europe, and so too for the largest banks in the U.S.

None of the recent events led governments to make capital injections into failing banks. By 2015, we concluded that the predictability of such solvency support had significantly reduced in the U.S., not least because the Dodd-Frank Act aimed to eliminate it, and also in Europe, where legal constraints were tightened and the political mood had shifted. Our view on this is unchanged. By contrast, we see government provision of substantial liquidity support to a solvent bank that is either in deep stress or in resolution as a standard policy response.

For systemic banks, we continue to believe that resolution planning, and the availability of loss-absorbing capacity that is subordinated to sensitive operating liabilities such as deposits, could strengthen the authorities' ability to engineer an outcome that avoids the sort of taxpayer-funded bail-outs seen in 2008-2009. Resolution also provides a fallback solution to authorities, which is why it remains our analytical base case for U.S. and European commercial banks if they become nonviable. Our expectation that public authorities will follow the resolution pathway does not negate the potential for future government-engineered in-market takeovers. Neither does it rule out with certainty the potential for injections of equity by public authorities. It simply reflects our expectation of what we believe to be public authorities' most likely course of action.

Over time, authorities' preference for engineering bank mergers to address liquidity failures could lead to more banking concentration. In those European jurisdictions with an overpopulated banking sector, this would most likely not be a near term issue. In Switzerland, on the other hand, the takeover of Credit Suisse by UBS may pose some competition and prudential issues over time.

Observation #1: Coordinated, rapid, and pragmatic action by public authorities remains our base case when financial stability is at stake

Faced with the failure or near-failure of large banks, the U.S. and Swiss authorities quickly applied their crisis management playbooks and implemented a range of crisis management tools to address financial stability concerns. Credit Suisse had experienced negative events over a sustained period, but for SVB it was more sudden. For both, deep stress arrived rapidly in the form of severe liquidity runs. This required rapid coordination and reaction among bank supervisors, resolution authorities, central banks as lenders of last resort, and governments, which in our view are the ultimate decision-makers when it comes to preserving financial stability.

In the U.S., the Federal Deposit Insurance Corporation (FDIC), in coordination with the Federal Reserve and the Treasury, determined it could use its "emergency systemic risk authorities" to resolve SVB and Signature, even though both banks were far smaller than the U.S. global systemically important banks (G-SIBs). That is, rather than adopting a "least cost" resolution strategy and selling or liquidating those banks at the time of failure (as it normally does), it transferred most of the assets and all the deposits (including uninsured deposits) to newly formed bridge banks – leaving the bonds and regulatory capital instruments behind. It did so to reduce the systemic risk it believed those banks posed. It has since sold most of the assets and liabilities of the bridge banks to other banks. SVB's parent holding company, which was not part of the bridge bank, subsequently filed for bankruptcy.

In addition to that resolution strategy, the Fed has also introduced emergency measures, such as the Bank Term Funding Program (BFTP) and an easing of the terms it offers through the discount window (its normal facility for extending liquidity to banks in need).

By contrast, in Europe, while there are many questions arising from the Credit Suisse rescue, the Swiss authorities employed tools that we have seen used before when banks failed or were under deep stress and governments have intervened: In-market acquisition by a larger stronger bank, burden-sharing by holders of capital instruments, significant liquidity support from the central banks, and a government second-loss guarantee for future losses. In both jurisdictions, the intervention was decisive.

Observation #2: The provision of extraordinary liquidity is a core crisis management tool, whether the bank is a going concern, or in resolution

With few exceptions globally, central banks are the lender of last resort to credit institutions. Terms of their collateralized refinancing facilities differ, but banking system confidence and stability relies on the mitigating role that central banks play for these highly leveraged institutions that undertake maturity transformation. Banks have routine access to the discount window and, in the U.S. also to the Federal Home Loan Bank (FHLB) system, which forms a standard portion of U.S. banks' financing that can be upscaled if needed. Access to emergency liquidity assistance (ELA)--that is, collateralized lending outside the normal facilities--is negotiable rather than a right and typically comes at a higher cost, but is nonetheless standard for solvent banks that undergo temporary difficulties.

In the U.S. and Europe, central banks have again proven willing to intervene when needed. For example, the U.S. Federal Reserve's BFTP makes loans of up to one year to eligible federally insured depository institutions, taking collateral in certain types of securities with margin at 100% of par value. This expands the liquidity value of these instruments and helps to avoid U.S. banks becoming forced sellers of these bonds (and so likely realizing losses on them). In Switzerland, the Swiss National Bank (SNB) lent to Credit Suisse under its standard refinancing facilities and then, on exceptional terms extended a Swiss franc (CHF)50 billion facility agreed days before the UBS transaction was finalized. The SNB then went further and provided two CHF100-billion liquidity assistance loans to UBS and Credit Suisse, the first one with privileged creditor status and the second one backed by a federal default guarantee--that is, against no collateral.

We would expect similar actions by any European central bank faced with the same situation. The parallel coordinated actions by the Fed, Bank of England, European Central Bank (ECB), SNB, Bank of Canada, and Bank of Japan to increase the frequency of dollar swap operations –for example as announced promptly after the UBS/Credit Suisse transaction-- similarly sought to avoid potential stress in funding markets that could lead to a shrinkage of credit supply.

Uncollateralized lending is not standard practice, but we have long noted that where central banks have the legal capacity to lend on an unsecured basis to a bank (thanks to a government backstop), this serves to enhance the credibility of the resolution process and to shore up confidence. The more comprehensive the backstop, the less likely it is to be needed. This legal capacity exists already for the Bank of England in the U.K., and is under consideration in the EU banking union. It was also under consideration in Switzerland but arrived rapidly when needed.

Observation #3: Authorities' reaction to a looming failure of a systemic bank will depend on the specific circumstances

In our view, regulators in the U.S. and Europe now have a comparable crisis management toolkit, at least as regards the largest banks, and with every bank failure or supervisory intervention, market observers glean insights from how these tools were deployed--not least because regulators generally hope to achieve time-consistent responses that aid predictability. Nevertheless, regulatory playbooks are not prescriptive. Circumstances will dictate how those tools are used but ultimately it is elected governments, who bear political responsibility, that need to endorse crisis management actions when financial stability is at stake.

We have observed that the specific circumstances that impact the course of action regulators' will take include:

• The cause of bank failure, e.g. solvency, liquidity, business model, or all of them.
• The options on the table to address or mitigate associated financial stability risks: a commercial deal while the bank remains viable, resolution, liquidation, or something else.
• The liability structure of the bank and losses (on assets, contingent liabilities, restructuring, etc.) that might need to be absorbed at the point of nonviability (PONV) or in a later restructuring phase.
• Legal constraints, such as no creditor worse off (NCWO) protections, or features of national insolvency law (which remains different across EU jurisdictions).
• The market environment (not least whether it's an idiosyncratic stress or market-wide stress).
• The preference of elected governments, informed by their assessment of financial stability risks and potential spillovers to the broader economy.

With this in mind, we view Credit Suisse as a bank that could have posed a global problem but which received a Swiss solution, dictated by the circumstances and political assessment at the time.

By contrast, we do not think that support for a failing bank is a one-size-fits-all equation across the 83 banking jurisdictions globally on which we maintain a banking industry country risk assessment. In the Asia-Pacific region, for example, we believe that extraordinary government support for a systemically important bank is the most likely support mechanism in 14 of the 18 banking jurisdictions where we rate banks. In Europe, we don't discount government support as impossible; we simply believe resolution is the more likely course of action. In Asia-Pacific, while resolution regimes and other bank-strengthening initiatives have progressed in many jurisdictions--and subordinated creditors of commercial banks will undoubtedly bear losses in a hypothetical major stress scenario--we ultimately believe that extraordinary government support would be at the forefront as a crisis-fighting tool.

Observation #4: For systemic banks in the U.S. and Europe, we believe credible resolution planning serves a broader purpose than being a fallback solution

Faced with a failing bank, we see it as a standard response that regulators may first try to facilitate its sale to a larger stronger institution. This is what the Swiss authorities achieved with Credit Suisse. However, this may be impossible or impractical: whether due to the speed of the demise, the lack of a willing buyer that is acceptable to the regulator, inability to perform proper due diligence, or doubts about potential contingent liabilities or other unmitigated downside risks. If a sale is not possible, regulators will determine that the bank has failed, and thereby trigger either a liquidation for a non-systemic bank, or a resolution for a systemic bank. A credible resolution plan creates a plausible way to ensure financial stability if a systemic bank were to fail, but it also serves a wider purpose: It changes the dynamics of the decision-making for the institution while it is still ailing.

For example, once an ailing bank has failed and is in receivership, a potential suitor might hope to secure a sweeter deal or cherry-pick certain assets. But the existence of a resolution plan means that this opportunity might never arise. Furthermore, if a bail-out is not on the table, the suitor's best interest may well be to acquire the bank at a steep discount to its net assets and recognize accounting badwill in regulatory capital that will in effect fund post-acquisition restructuring. Furthermore, for the ailing bank's shareholders, even a sale at a deep discount (as seen for Credit Suisse) is likely to be preferable to being zeroed out in receivership or resolution.

Observation #5: We may see greater convergence between European and US authorities regarding resolution for second- and third-tier banks that provide critical functions

Europe and the U.S. offer a contrast in the stance of the authorities' analysis of the financial stability risks posed by the failure of banks that sit below the top tier of G-SIBs. In Europe, authorities plan to use resolution tools, i.e. avoid standard liquidation proceedings, for any bank that provides critical functions to the economy, and therefore asks these banks to maintain a loss-absorbing debt buffer on top of their capital requirements and make other preparations for resolution. In practice, this includes swathes of second tier and some third tier banks in national banking systems, some with balance sheets below €10 billion, depending on the jurisdiction.

In the U.S., G-SIBs are required to make detailed resolution plans. Their total loss absorbing capacity (TLAC) requirements are meant to facilitate the preferred single point of entry (SPE) resolution route. That is, while the G-SIB's top level holding company enters bankruptcy, its TLAC effectively absorbs losses at the operating companies, giving them a higher probability of avoiding failure. If at the point of bank failure, the FDIC, in conjunction with the Fed and Treasury, sees systemic risk in using that SPE strategy, it can fall back on the systemic risk exception to manage the resolution itself.

By contrast, U.S. banks other than G-SIBs have no TLAC requirements. The FDIC's standard policy option is to sell or liquidate a failed bank (with the bank holding company, if there is one, going into bankruptcy), aiming primarily to minimize any losses to the deposit insurance fund. However, as it did with SVB and Signature, the FDIC may also use the systemic risk exception. This opens up other options, including the use of a bridge bank strategy, and extension of liquidity to the bridge bank if necessary.

Still, the U.S. authorities more recently acknowledged that large domestic systemically important banks (D-SIBs) could pose complex challenges if they fail and are liquidated. The Fed last year issued an advanced notice of proposed rulemaking (ANPR) to solicit public feedback on plans to require large regional banks to hold an extra layer of loss-absorbing capacity. If adopted, the U.S. would be moving more toward the European model, although the proposed plan would not have included SVB (with its $212 billion of assets) in its scope. The FDIC Chair's comments to the Senate Banking Committee on March 28 nevertheless indicate that the FDIC will consider whether new regulations should require a wider swath of banks to hold bail-in-able debt.

Observation #6: Deposits are special

When SVB and Signature became nonviable, while their insured depositors were protected (up to the $250,000 limit), their uninsured depositors faced the prospect of substantial delays and possible haircuts in getting paid out. Confidence in some other regional banks quickly eroded. The FDIC in turn used the systemic risk exception to extend the guarantee to all deposits in the two banks. These measures, with others, appear to have largely stemmed contagion risk but in our view they exacerbated the moral hazard concern, that is, the perceived need to ensure that sophisticated investors and depositors are risk-sensitive. The decision to extend deposit insurance to uninsured depositors of these banks is not unprecedented, but it acknowledges that when such deposits emanate from the real economy, this risks that businesses would be unable to pay employees and suppliers. The FDIC is expected to soon report on whether there is an argument to extend deposit insurance, and also on the associated cost of doing so.

In Europe, the claims of uninsured depositors are technically bail-in-able and in most countries rank pari passu with other senior preferred creditors such as bondholders. However, deposits are typically not included in banks' minimum requirement for own funds and eligible liabilities (MREL) buffers because their contractual maturity tends to be too short and banks fill these buffers instead with long-term debt, much of it subordinated. European resolution authorities recognize also that deposits are confidence-sensitive operational liabilities for a bank, critical to the viability of its franchise, as well as its funding. Imposition of substantial haircuts on uninsured deposits was already used in Cyprus in 2013, and we sense little appetite among European public authorities to revisit it. Indeed, we see it as notable that the insolvency laws of Greece, Italy, Portugal and some other European countries rank some or all uninsured deposits above other senior preferred claims, such as commercial paper and bonds. Given the requirement for systemic banks to maintain substantial MREL, this provides a material loss absorption buffer for the benefit of their depositors.

As part of their review of the EU crisis management and deposit insurance (CMDI) framework, policymakers have debated whether to extend this general depositor preference across the EU. We already considered this likely and now consider it a virtual certainty after the European Commission proposed this measure in its draft legislative package announced on April 18. The proposal does not propose a change to depositor insurance beyond the current €100,000 limit in the euro area, but does envisage to extend coverage to public entities. Furthermore, U.K. policymakers have indicated that they may review the U.K. deposit insurance scheme--they could, for example, increase the current £85,000 limit, expand protection for businesses, and/or increase the level of scheme prefunding.

Observation #7: Government solvency support in the U.S. and Europe remains a less reliable prospect than in years past

As the GFC showed, the line between systemic and non-systemic institutions often gets blurred in acute times of systemic crisis--the U.S. government provided wide-ranging solvency support to the banking sector through its capital purchase program that saw it invest more than $200 billion in capital instruments of large and small institutions, itself part of the wider $700 billion troubled asset relief program. The beneficiaries included SVB and Signature Bank, albeit they were much smaller at that time. This time the parallels are more with Washington Mutual--still the largest U.S. bank failure--which was put into receivership in 2008 and parts of it later bought by JP Morgan. In Europe, many sizable banks received solvency support, for example in Ireland, Spain, U.K., Germany, Netherlands, and Belgium. In Switzerland, the government rescued UBS with a comprehensive package of support.

As regards Credit Suisse, the Swiss government has provided a tranche of CHF9 billion second-loss balance sheet protection--a tool similar to that deployed for UBS in 2008 and later in the form of bad asset protection programs in Greece, Italy, and other countries. This was not a classic solvency stress, so [it is] not comparable with banks that failed during the GFC. Nevertheless, it's notable that there was no serious policy suggestion that the government should inject capital into Credit Suisse as part of the earlier capital raise or if UBS baulked at the last-minute commercial transaction. SVB and Signature were far less systemic than Credit Suisse, but it is unsurprising to us that the government should have intervened to avert their failure. We do not totally rule out such support in the future for systemic banks, but we remain convinced that the prospect of government solvency support through capital injections remains uncertain in the U.S. and Europe.

Observation #8: Policymakers that double-down on resolution will need to redouble their efforts to guide market expectations

In the years following the GFC, leading global regulators, through the Financial Stability Board (FSB), acknowledged the need to significantly expand their crisis management toolkit. This has since been achieved in much of the G20. However, regulators and policymakers understand that the creation of a framework that facilitates burden-sharing by bank creditors does not in and of itself change investor expectations. Indeed, we see a sharply contrasting policy intent between the move from bail-out to bail-in in the U.S. and Europe and developments in other countries. By contrast, we have not revised our expectations of likely substantial government solvency support for systemic banks in major Asia-Pacific countries, but we did for Europe and the U.S. In part this was because European and U.S. policymakers and regulators have compelled the banks that they deem systemic to make themselves resolvable. Furthermore, it partly reflects our opinion of the greater likelihood of government support in some banking jurisdictions in a hypothetical banking crisis in preference to a European style resolution, most notably in Asia-Pacific. This is despite strong progress across Asia-Pacific in initiatives that vary by jurisdiction and include building additional loss-absorbing capacity (ALAC) buffers, strengthening core common equity capital levels, or stipulating minimum buffers via subordinated debt and hybrids.

Indeed, despite the stated policy intent in the U.S. and Europe, some investors have continued to assume that government solvency support would likely remain available to leading banks in these regions--because they remain too big to fail. After all, no authority has yet attempted to resolve a leading bank, and certainly not a G-SIB. Regulators have not yet demonstrated the time-consistency of resolution as a standard response.

In theory, Credit Suisse was one of the European banking groups best prepared for resolution--FINMA's published assessment confirmed this. As we note above, the commercial transaction with UBS does not, in and of itself, challenge the idea that resolution was a credible backstop. However, statements by the Swiss government since the deal announcement suggest that it had doubts that resolution could have achieved the key objective of ensuring financial stability. The specific circumstances of the nature of Credit Suisse's stress and the market confidence context will have been part of that decision. However, these events will have further clouded market expectations about whether European public authorities, not only in Switzerland, have genuine intent to resolve failing systemic banks.

Investors understand that European and U.S. bank regulatory capital instruments can take losses if a bank fails, or sometimes earlier--there is a long track record of this happening. The write-down to zero of the Credit Suisse Additional Tier 1 instruments highlights the tail risk associated with these instruments, with investors in the Tier 1 preferred stock of SVB and Signature Bank also likely to bear significant losses. However, it's not just regulatory capital instruments that can be bailed in.

The bail-in tool—which would be used to convert the claims of senior nonpreferred (SNP) creditors and nonoperating holding company (NOHC) senior creditors, and potentially also senior preferred creditors--remains unused in practice. SNP and NOHC senior bonds are recapitalization instruments but, unlike Tier 1 instruments, also funding instruments, because of the volumes that banks issue. Despite their subordination and contractual acknowledgement of bail-in risk, which we reflect in our ratings on such instruments, they have long traded nearer to senior preferred debt than to Tier 2 subordinated debt, possibly reflecting that they are not part of regulatory capital. As a result, there could be great surprise from some quarters when resolution authorities decide to bail-in SNP or NOHC senior debt issued by a failed European bank. For a resolution action on a leading bank to be successful, in our view it will need to maintain (or even rebuild) market confidence and be comprehensible by stakeholders at large--including politicians, bank customers, and the wholesale markets. Management of investors' expectations as we see it therefore remains critical for public authorities that intend to go down this path.

Observation #9: Resolution remains our analytical base case for systemic banks in the U.S. and Europe

Notwithstanding our observations above that bail-in-led resolution remains unproven as a path for European and U.S. leading banks, we continue to see it as the most likely outcome for a failed systemic bank. We therefore uplift our issuer credit ratings on many of these banks with notches for their additional loss absorbing capacity (ALAC). This reflects the substantial progress that banks have made to ensure that they are resolvable, but also the unpredictability of government solvency support, and the implausibility that liquidation would be consistent with financial stability. That said, this doesn't mean that public authorities wouldn't also take steps to reinforce public confidence when they pursue a resolution action.

Observation #10: Financial stability and monetary policy tightening are bound up together, but not mutually exclusive

Central banks have demonstrated that they can address financial stability while at the same time continue their monetary policy tightening--a few days after providing the liquidity assistance to UBS and Credit Suisse, the SNB proceeded to raise its main policy rates by 50 basis points. That said, we remain highly mindful that policy rates have not yet peaked in many countries, quantitative tightening (i.e. the scaling down of central bank investment portfolios) has barely started, and market confidence cannot be taken for granted. Monetary authorities will need a deft hand to balance both objectives.

Observation #11: The exit of a failed player can lead to banking consolidation, though the systemic benefits may be mixed

This could be a positive in an overbanked market--for example there was heavy consolidation in Spain following the GFC, a process that continued when Santander acquired failed Banco Popular in 2017 and through several negotiated in-market deals, not least when foreign competitors exited the market. However, in an already quite concentrated domestic banking system like Switzerland, this could lead to complexities over time.

Related Research

• Credit FAQ: Asia-Pacific AT1 Hybrids Investors: Understanding The Credit Suisse Fallout, March 24, 2023
• Swiss Regulator's Statement On Credit Suisse AT1 Confirms Impact Of Documentation And Legislative Powers, March 23, 2023
• European Bank AT1 Hybrids In A Post-Credit Suisse World, March 21, 2023
• European Banks Can Weather The Market Turmoil, March 21, 2023
• SVB Default And Asia-Pacific Banks: Secondary Effects Are The X-Factor, March 16, 2023
• Unrealized Losses: The Rate-Rise Risk Facing Banks, March 16, 2023
• Economic Research: The Macro Fallout From The Silicon Valley Bank Collapse Appears Limited For Now, March 16, 2023
• European Banks See Limited Contagion Risk From SVB, March 15, 2023
• The Fed's Plan For U.S. Banks Should Reduce Contagion Risk, March 13, 2023
• Asia-Pacific Banking: Government Bailouts Are Still Likely In The Event Of Systemic Crisis, Oct. 10, 2022
• The Resolution Story For Europe's Banks: The Final Push To Resolvability, Sept. 30, 2022