Credit Suisse Shows Banks Still Need More Capital

(Bloomberg Opinion) -- Yet again, trouble at a big European bank, this time Credit Suisse Group AG, is roiling markets. Concerns about the cost of an expected restructuring have sent its share price gyrating wildly, leading both executives and analysts to appeal for calm and emphasize that the bank is among the best capitalized of its peers.

If only that comparison were more reassuring. As the tempest surrounding Credit Suisse demonstrates, the world's largest banks remain too fragile — a long-running shortcoming that policy makers must address.

Bank capital plays a crucial role in the financial system and the broader economy. It's not, as often portrayed, cash set aside for a rainy day. It's equity from shareholders, money that can be used to make loans and other investments. As opposed to debt, it has the advantage of absorbing losses. The more banks have, the better they're able to take risks, make loans, prevent contagion, transmit monetary policy and generally promote prosperity.

The biggest global banks have a lot more capital than they did when the last major crisis hit in 2008, and Credit Suisse does indeed stand out. As of June, its leverage ratio — a relatively simple measure of capital as a share of assets — was 6.1%, significantly higher than those of systemically important European peers such as BNP Paribas SA and Deutsche Bank AG.

In the US, levels are likewise much improved since the financial crisis, though they've declined somewhat in recent years. For the four largest US banks, the weighted average ratio of tangible equity to tangible assets stood at 6% in June, down from a peak of 8.4% in 2015. (That's not exactly comparable to European banks, due to differing definitions of assets and capital.)

Problem is, experience and research suggest they'd all need a lot more to survive a severe crisis and still have enough left to inspire confidence. Back in 2009, during the darkest days of the subprime mortgage bust, the International Monetary Fund projected that total losses on loans and securities would amount, on average, to almost 8% in the US and Europe. Some research suggests they'd need about twice that much capital to bring the probability of bailouts down to an acceptable level.

This fragility has consequences even in relatively calm times, allowing what could have been manageable issues — such as the possible multi-billion-dollar cost of Credit Suisse's yet-to-be-detailed restructuring, coming after last year's $5.5 billion loss related to the implosion of Archegos Capital Management — to morph into mini-crises. And at a moment when the combination of a global pandemic, an energy emergency and the war in Ukraine have increased governments' debts and reduced their capacity to undertake bailouts, it leaves the whole financial system unduly vulnerable.

The prescription for policy makers in the US and Europe is simple: Hold the line on capital, and keep pushing for more. The danger of having too little far exceeds that of demanding too much.