The Frankenstein Merger: UBS and Credit Suisse Join Forces, but at What Cost?

The Swiss banking world was rocked by the news of UBS's acquisition of Credit Suisse, brokered by the Swiss authorities over the weekend. The acquisition, at a price of $3.25 billion, which is less than half of the bank's market capitalization at the close of trading on Friday, is seen by many as a significant undervaluation and a major blow to the reputation of Credit Suisse. In this article, we will take a deep dive into the causes and implications of the UBS and Credit Suisse merger.

Causes of bank failures

The financial industry has been prone to instability since its inception. The causes of bank failures in the past have been attributed to various factors. One of the most significant causes of bank failures is the deflationary effect during the 1920s. During this period, banks lent out more money than they had in reserves, which led to a massive wave of bank failures. Another major cause of bank failures was sub-prime lending in the 2007-2008 financial crisis. Banks extended credit to people with poor credit histories, and when the housing market collapsed, the value of the mortgages plummeted, leading to a domino effect that spread across the financial industry.

Implications of the UBS and Credit Suisse merger

The acquisition of Credit Suisse by UBS has significant implications for the Swiss banking industry and the global financial system. The fact that Credit Suisse, a bank with a rich history spanning over 167 years and regarded as a prestigious brand for the world's wealthiest individuals, was sold at a price less than half its market capitalization has sent shockwaves across the industry. However, the bank has struggled financially in recent years, experiencing losses of $860 million and $7.9 billion in 2021 and 2022 respectively.

UBS will need to absorb these losses and assume some of Credit Suisse's debts, which are over $160 billion. To mitigate some of these losses, the AT1 bonds worth $17 billion were written down, and the Swiss government would provide more than $9 billion to backstop some losses for UBS. However, UBS will still have to undertake significant restructuring efforts, which will be a major challenge and a drag on UBS performance in the coming years.

The shareholders of Credit Suisse will likely suffer the most, as an investor who purchased Credit Suisse stock at CHF7.18 just a year ago would receive only CHF0.76 per share, resulting in a staggering 89% loss. Furthermore, Credit Suisse shareholders will be receiving UBS shares instead of cash, and some of these shareholders may choose to sell the UBS shares, which could weigh down the share prices further. Not all holders of Credit Suisse bonds are spared, as a special class of AT1 bonds that were created during the last financial crisis in 2008 have been rendered worthless, while other bonds are still honored.

The broader implications of the UBS and Credit Suisse merger highlight that merging banks to improve their financial strength is a temporary solution rather than a permanent one. As banks become larger through these mergers, they also become too big to fail, making future rescue packages even larger and more challenging. In this case, the UBS and Credit Suisse merger is joining two systemically important banks together, and the pillars of the Swiss banking system are left with one instead of two. While the move may be a short-term solution, this may be a Frankenstein in the making, potentially increasing the risk of a more dangerous failure down the road.

Final thoughts

The UBS and Credit Suisse merger is a significant event that has caused shockwaves across the financial industry. It highlights the fragility of the banking system and the potential risks that can arise from over-leveraged and poorly managed banks. The acquisition of Credit Suisse by UBS is a reminder that even the most prominent financial institutions are not immune to failure. While the merger may help UBS and Credit Suisse survive in the short term, it does not address the underlying issues that led to Credit Suisse's financial struggles.

Moving forward, it is crucial for the Swiss government to address the issues that led to the downfall of Credit Suisse and to implement measures to prevent similar occurrences in the future. The UBS and Credit Suisse merger is a wake-up call for the Swiss banking industry and the global financial system. It is time for banks to reassess their business models and risk management practices to ensure a more resilient and sustainable financial system.