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Preemptive risk management is needed for financial crises

Preemptive risk management is needed for financial crises

Posted March. 17, 2023 07:44,   

Updated March. 17, 2023 07:44


The fears of a financial crisis, first sparked by the collapse of Silicon Valley Bank (SVB) in the U.S., are now spreading to Europe. Swiss investment banking (IB) firm Credit Suisse (CS) is at the center of concerns. As a result, stock prices of both American and European banks are declining rapidly, and credit ratings are also in danger of dropping soon.

The crisis facing Credit Suisse (CS), one of the world's nine largest investment banks, was triggered by the disclosure in its recent annual financial report that "significant weaknesses in internal control" had been identified. Furthermore, when the National Bank of Saudi Arabia, CS's largest shareholder, announced that it would not provide additional liquidity, the bank's stock price plummeted by almost 30% in a single day. In addition, CS suffered a loss of over 7 trillion won due to a failed investment in Akegos Capital, run by Korean-American investor Bill Hwang, two years ago. This led to a rapid increase in customer deposit withdrawals since the end of last year.

The crisis faced by CS is distinct from that of SVB, which invested more than half of its assets in U.S. Treasury bonds, a safe asset, but went bankrupt due to a drop in government bond prices following a rise in interest rates. However, the global financial market is currently engulfed in anxiety and is in an extremely sensitive state where even a small negative event can immediately lead to a cash withdrawal crisis. If CS, a large worldwide bank, were to go bankrupt, the impact on the global financial market would be incomparably greater than that of SVB, which had Silicon Valley venture companies as its customers.

After initially stating that “the effect on the Korean financial market will be limited” following the SVB crisis, Korean financial authorities are urging domestic banks to increase their equity capital. In the case of domestic banks, the equity capital ratio, which shows how much they can make up for assets that have been lent and but not returned with their own capital, is 12.26%. It is lower than that of the European Union and the U.S. This ratio may decline further as shareholders have recently been pushing for higher dividends.

Korea's financial system is different from those of the U.S. and Europe in that it has a massive household debt burden that exceeds gross domestic product (GDP). In addition, with mobile banking being common in Korea, the risk of a “digital bank run” similar to SVB's rapid bankruptcy in 36 hours may be even greater. Therefore, the financial authorities should conduct a “stress test” promptly, assuming a worst-case scenario, to urge banks to build up sufficient capital in advance. Financial companies must also refrain from excessive dividend payments and incentive payments to employees.