Bank for International Settlements working paper finds Credit Suisse episode weakened bail in credibility and market discipline in Europe

The Bank for International Settlements has published a working paper concluding that the March 2023 failure of Credit Suisse weakened the perceived credibility of bail in for European banks and reduced market discipline. The paper examines how investors repriced different layers of bank debt after Swiss authorities facilitated a UBS takeover backed by public guarantees, wrote down Credit Suisse Additional Tier 1 bonds in full, and left bail in creditors untouched. Using bond level data from 94 banks in 22 countries, the authors find that markets came to assign a lower probability to bail in creditors bearing losses in a crisis. The paper finds that Additional Tier 1 spreads moved differently across jurisdictions, rising in Switzerland where those instruments were written down and falling in the euro area and the United Kingdom after authorities clarified the creditor hierarchy for Additional Tier 1 instruments. By contrast, bail in bond spreads tightened across all three jurisdictions, while senior bond spreads changed little, indicating that markets reassessed how losses would be allocated rather than the overall likelihood of bank failure. Lower rated banks saw larger declines in bail in funding costs, credit default swap subordination premia narrowed, and investors reacted less to bank earnings announcements, all of which the paper interprets as evidence of weaker bail in credibility and reduced creditor monitoring. The publication notes that the views expressed are those of the authors and not necessarily those of the BIS or its member central banks.