Banks need to pre-position as much collateral as possible at the central bank to avoid regulators being caught out by illiquid and unacceptable assets, such as yachts or ships, former Bank of England deputy governor Paul Tucker told a high level central banking gathering in Basel on Wednesday.
The former banking supervisor was drawing on conclusions he submitted to the Swiss Finance Ministry last year as part of a specially commissioned report into Credit Suisse’s collapse in March 2023. That assessment pinned much of the blame for the collapse on how the bank’s wealth management division was run.
“The run on the wealth management business not only drained funds but also impaired the group’s franchise (and hence the credibility of its business plan),” the report noted.
In his Basel address, Tucker said the lessons to be learned from the Credit Suisse collapse “dwarf” anything to be learnt from the associated U.S. banking crisis that happened at roughly the same time. “It is the most extraordinary thing there isn’t more debate about this.”
The report, which was only published on April 10 — alongside the Swiss government’s own report into Credit Suisse’s failure — presented a scathing critique of the Swiss National Bank’s lender of last resort (LOLR) practices.
An overly opaque SNB
These were judged to be overly opaque and excessively dependent on poorly publicized emergency liquidity assistance protocols. “Before the CS crisis, the SNB had said very little publicly — perhaps more privately to some banks — about its approach to LOLR,” the report noted, adding “there were no public facilities except for handling payments-system frictions, and hence, stabilization of the monetary policy rate of interest.”
Instead, all LOLR support was to come from emergency liquidity assistance (ELA).
In the end, however, that ELA regime proved grossly ineffective at addressing failings that were driven by collapsing customer confidence in Credit Suisse’s franchise, rather than by capital issues.
Tucker told the audience, which had gathered to celebrate the 50th anniversary of the Basel Committee on Banking Supervision at the Bank for International Settlements, you can’t resolve such a predicament by putting more equity in an institution. If you don’t want the institution to go bankrupt “something closer to conservatorship can sometimes be needed where the central bank ends up funding a full scale run,” so that “there’s a kind of controlled runoff of the group,” he said.
Another key finding in Tucker’s report was that by the time Credit Suisse needed to tap SNB liquidity, most of the bank’s eligible collateral was already tied up in collateral arrangements with other private counterparts leaving little left for pledging at the central bank.
At the same time, the SNB’s ELA regime had been structured around a preference for Swiss mortgage collateral, when much of Credit Suisse’s wealth management was conducted in foreign currencies and foreign assets.
The yacht problem
In Credit Suisse’s case, however, simply broadening the collateral eligibility pool to include foreign assets may not have been enough to save it. “Turns out that there are some banking models that in their very nature may not carry enough assets that any central bank would lend against because for example, the bank has lent to a tycoon to liquefy the wealth in the business they’ve founded,” Tucker told the Basel audience.
He was alluding mostly to loans collateralized by yachts or ships “owned by vehicles domiciled in an offshore island” and registered or moored in other obscure places. “I don’t think any central banker on Earth would want to collect such assets,” he said.
Even so, had Credit Suisse moved to a pre-positioning framework early enough the regime might have given regulators a heads up on the bank’s collateral shortcomings, while revealing which parts of its asset book should be funded with equity or long-term debt.
“[The system] would be especially useful for the Swiss authorities as it would ensure that SNB had to get to the bottom of what exactly is available where, what obstacles need to be overcome, and whether they can be overcome to the satisfaction of the Swiss authorities,” the report said.
Tucker’s ultimate preference is for a framework which would require banks to cover all of their short-term liabilities with reserves or collateral pre-positioned with the central bank, while elevating the role of collateral management in financial stability policy.
But it’s not just the Swiss system that stands to benefit from making pre-positioning a central banking norm, according to Tucker.
“The need for this change is such an important lesson from the CS affair, with significance for both Switzerland and every other major banking center,” the report said.
Former Bank of England Governor Mervyn King is also publicly supportive of the idea.
