How Does a Bank Fail? 8 Reasons Why Credit Suisse Collapsed (Part One)

In the following series of articles, we’ll chart out 8 of the significant structural reasons, and the utterly ridiculous reasons underpinning the failure of one of the world’s too-big-to-fail banks, in the hope that somewhere buried underneath it all is a lesson or two for the rest of us.

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How does a bank fail?

Silicon Valley Bank showed how poor investing and sector overweight can do the trick.

Formerly the sixteenth largest bank in the U.S., SVB’s assets skyrocketed from around 71 billion dollars in 2019 to over 210 in 2022. During its intense growth, the bank made a seemingly safe bet, snapping up long-term treasury bonds. But as inflation grew, and the Federal Reserve raised interest rates, the value of those bonds declined, and by year’s end the bank had piled up 15 billion dollars in unrealized losses. It couldn’t have come at a worse time for an institution overwhelmingly servicing the technology industry, which hit a snag right at that same time. Customers began withdrawing their money, social media helped it snowball into a proper bank run, and before long SVB was insolvent.

Signature Bank can pin at least some of its woes on SVB, as the failure of the latter precipitated a run on the former. But investors and the FDIC noted plenty of other contributing causes, like holding just 5% of its assets in cash, and insuring only 10% of its deposits. And SVB’s tech concentration looks conservative compared to Signature’s overexposure to cryptocurrency – 25% of its deposits having come from the notoriously volatile industry.

Over a year after Signature, First Republic fell for many of the same reasons. That’s not to say all banks fail in this same way, though. Sometimes a once-in-a-generation event like the Financial Crisis can weed out the vulnerable. All variety of management failures, risk miscalculations, and lack of oversight can contribute. There are macroeconomic components to these stories, as well as psychological ones.

And then there’s Credit Suisse.

The reasons for the downfall of Credit Suisse outnumber all of the reasons for SVB, Signature, and First Republic combined, probably because, at its peak, Credit Suisse could have eaten all of those other banks for breakfast. The 167 year-old bank, at its peak, reached a valuation equivalent to nearly 90 billion U.S. dollars, and still had 1.3 trillion in assets-under-management (AUM) just months before its utter collapse.

Taking down a behemoth like that would’ve required a whole lot more than some bad bonds, some sector concentration, or, god forbid, social media. No, the story of Credit Suisse’s demise encapsulates scandals of a scope both internationally significant and utterly petty. It involved risk miscalculations and management turnover, but also regulatory battles, repeated illegal activity, and some terribly bad luck. Along the way there was spying, smuggling, a suicide, and major world-historical events.

In the following series of articles, we’ll chart out 8 of the significant structural reasons, and the utterly ridiculous reasons underpinning the failure of one of the world’s too-big-to-fail banks, in the hope that somewhere buried underneath it all is a lesson or two for the rest of us.

#1 Having a dirty business model

In 2014, a “veteran” Swiss banker agreed to speak with the New York Times. His identity was shielded, for fear of certain reputational, financial, and legal punishment if anybody were to find out it was him revealing such closely guarded information.

He and his colleagues in the business, he claimed, spent much of their time lining the coasts of the U.S., traveling between big cities, staying at luxury hotels, and rendezvousing with prospective clients at ritzy events and galas. They were recruiting wealthy clients, as covertly as humanly possible.

He said the bankers carried special laptop computers formatted so that information could be wiped out instantly with a few keystrokes, and portable printers to avoid leaving traces elsewhere. They avoided staying in the same luxury hotels, switching if anybody recognized them or called them by name. He said he cut the name of the bank off receipts. Customers called from pay phones, using code names.  He said he carried separate paper lists, one with code numbers and one with corresponding names. Those names did not surface on bank records because they were shielded in a maze of offshore trusts and foundations, he said.

It should be no wonder, then, why Switzerland is commonly referred to as the “grandfather of bank secrecy.”

Back in 1934, the Swiss government passed a comprehensive banking law, most famous for its Article 47. In fact, some of the articles in the bill existed exclusively to enforce Article 47.

Article 47 made it a federal crime to disclose any information about bank clients – without their consent, or a relevant criminal complaint – to anybody. That included third parties, foreign entities or authorities – even governments and law enforcement – or even Swiss authorities. The penalties for breaching Article 47 included six-figure fines, and three to five years in prison.

Arguably, the law wasn’t even necessary. The country’s tradition of banking secrecy dated back to the Middle Ages, and the career damage to anybody who violated the rules both written and unwritten would be severe. And so, to date, less than a handful of individuals have broken the code.

Combined with the relative stability of the Swiss Franc, and the country’s other most famous quality – its neutrality in war – the Swiss banking sector exploded off of its reputation as a tax haven and hub for money laundering. By the 21st century, its two biggest brands – UBS and Credit Suisse – managed trillions of dollars annually for foreign entities.

The situation changed in 2010, when the United States signed into law a new jobs bill, including a Foreign Account Tax Compliance Act (FATC). In an effort to increase tax revenue, FATC required that foreign financial institutions share details about their American account holders’ assets, imposing a 30% tax on all funds originating from the U.S. for any that didn’t comply.

This put Swiss bankers in a Catch-22 – either they could violate U.S. law by keeping their clients’ information secret, or Swiss law by not. “I remember a party a few years ago with other bankers,” the New York Times informant recalled, “and I said, ‘You know we all have one foot in prison.’ Everybody laughed. Maybe that’s why we were all paid so much.”

FATC certainly didn’t kill Swiss banks’ most lucrative income stream, but it did put a dent in it, and open the door for conflicts to come.

#2 Facilitating Severe Crimes

In February, 2022, an email written by a Credit Suisse banker was presented before a Swiss court. It read, in part:

After the homicide we have decided to continue the business relationships. The said (short and imprecise) article linking the murder to Spanish cocaine…has not been confirmed.

The email was referencing a report about an associate of Evelin Banev – a Bulgarian former wrestler, convicted drug trafficker and money launderer, and client of Credit Suisse. Two years after Banev’s associate was murdered, the victim’s mother was supposedly set to testify against Banev before she, too, according to Reuters, was murdered.

A Credit Suisse banker on trial that February claimed she’d warned her managers. She told the court that “the reaction I received when talking with my hierarchy, the questions were: ‘Was the person killed a bank client?’ ‘No, she was not.’ ‘Is she in any way linked to the bank, do you know her?’ I said: ‘No, never met her.’ And then the reaction was, well then what is your problem?’” The bank managers who testified claimed to have little memory of the case.

Criminals found refuge in Swiss banking, whether they came from Bulgaria, other countries, or within the company’s own four walls.

Patrice Lescaudron was one of the top three performers in Credit Suisse’s all-important wealth management division, according to the Financial Times, earning as much as 12 times more than his colleagues in the same branch.

But for more than a decade, the financial advisor was also stealing money from some of his wealthiest clients in order to support his extravagant lifestyle. For example, from just one of his accounts – held by Bidzina Ivanishvili, a former prime minister of Georgia – he managed to siphon off an estimated 926 million dollars. He was convicted, and died in 2020 after a short stint in prison.

A 270-page report from the Swiss Financial Market Supervisory Authority (FINMA) found that Lescaudron had acted alone. However, the illegal activity was hardly covert. It “triggered hundreds of alerts,” the report revealed, including hundreds of suspicious transactions, and four disciplinary hearings “that weren’t fully probed in the 2009-15 period studied.” Credit Suisse was guilty of poor oversight, and ordered by a Singapore court to pay back Ivanishvili the nearly one-billion-dollar difference between his account balance, and his expected returns had he received proper treatment.

#3 Festering a Toxic Management Culture

In September, 2019, Iqbal Khan, the head of international wealth management at Credit Suisse, filed a report with the Swiss police. Somebody was following him and his wife.

Khan – a handsome man with blue eyes, slicked-back hair and a chiseled jawline –  was the fastest-rising star at the bank. And despite being a high-profile executive, he lived in the relatively modest, small town of Schwyz, 45 minutes’ drive to Zurich. According to legend, on an early trip to hire new members of his team at Credit Suisse, the multimillionaire flew to South America in economy class.

Khan’s combination of humility and relentless ambition earned him lots of popularity. He was a high performer yet, as one colleague told The Financial Times, “he’s the kind of guy who will treat a waiter just the same as he would a chief executive.” The company’s CEO when he joined, Hans-Ulrich Meister, often said that Khan was the best hire he ever made. Many figured Khan would one day be the CEO himself.

Everything changed when he moved from his home in Schwyz, into a property on Lake Zurich directly next door to Meister’s successor, Tidjane Thiam.

As a fellow executive put it: “To me, moving in next door like that, there are two signals you might be wanting to send. Either: ‘We get along so well I’d like to spend more time near you,’ or else: ‘I’m coming for you.’”

Rumors suggest a power struggle between the two men at work, manifesting in petty arguments at home over property improvements and blocked views. Neighbors observed the tension reach a boiling point at a neighborhood cocktail party in January, 2019. Two months later, when the CEO attended his lieutenant’s annual party for his team, “there was a noticeable chill between the two men,” according to the Financial Times.

The rift that opened in January had widened. If Mr Khan was happy to dole out praise to those under him, he also expected his own achievements to be recognized. When it became clear that Credit Suisse’s chairman, Urs Rohner, would not force Mr Thiam to give Mr Khan more of the limelight, he began talking to rivals.

As he did with his home, Khan decided to move next door: to Credit Suisse’s rival, UBS.

Even after that, it seems, his enemies within Credit Suisse weren’t done with him. Reportedly without involvement from Thiam, an investigator was hired to follow Khan and determine if he was trying to poach Credit Suisse clients.

The reality show drama at the highest rungs of the company was emblematic of a broader cultural failure, where executives with fiery personalities and sometimes crazy ideas were appointed and then flamed out just as quickly. In its dying embers, Credit Suisse blew through three CEOs in three years, and chairmen just as quickly. There was Antonio Horta-Osorio, for example, who after taking over the reigns promised to develop “a culture of personal responsibility and accountability.” Nine months into his tenure as chairman, he resigned, having broken COVID quarantine rules to attend Wimbledon.

It’s difficult to imagine how any company would’ve survived the sheer incompetence demonstrated at the highest levels of Credit Suisse. But luckily for those executives, there were broader structural reasons for the bank’s collapse, upon which analysts could later pin the majority of the blame.

Read more, in Part 2 of “8 Reasons Why Credit Suisse Collapsed.”

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