The Reaction of Swiss Bank Stock Prices to the Russian Crisis

The reaction of Swiss bank stock prices to the Russian crisis Bertrand Rime1 1. Introduction On 17 August 1998 Russia announced a debt moratorium after several weeks of pressure on the rouble exchange rate and tension on the Russian treasury bill markets. The Russian financial collapse represented one more episode in the financial turmoil that had been affecting emerging market economies since the floating of the Thai baht in mid-1997. The spreading crisis in emerging markets raised concerns about the financial stability of a number of western and Japanese creditor banks. Crisis fears culminated in September 1998 with the near-collapse of the hedge fund LTCM. Some analysts pointed to the risk of contagion among international banks and to the systemic repercussions that the failure of a large creditor bank might have on the domestic banking sector of its home country. The loss of investor confidence led to a 30% fall in the stock markets of the developed countries during the third quarter of 1998. The issues of contagion and systemic risk have a particular dimension in Switzerland for two reasons. First, the Swiss banking sector is highly concentrated by international standards. This is especially true for the domestic interbank market, where the two big banks represent about 65% of total liabilities. Secondly, the two big Swiss banks are highly involved in international banking and have been significantly affected by the Russian crisis and the LTCM debacle. In this paper, we try to assess the impact of the Russian moratorium on Swiss banks. Using event study methodology, we compute Swiss bank stock returns for a number of events related to the Russian moratorium. In a second step, we regress each bank’s stock returns against dummy variables reflecting the bank’s category. The paper is organised as follows. Section 2 provides a detailed chronology of the Russian crisis. In Section 3 we introduce the event study methodology and the cross-sectional regression model. In Section 4 we present the results of the event study and of the regression analysis. Section 5 concludes. 2. Chronology of the Russian crisis In this section, we try to identify the events related to the Russian moratorium that are most likely to have affected Swiss bank stocks. The 69th Annual Report of the Bank for International Settlements (1999, pp. 50–2) provides a well- structured chronology of the Russian crisis: “Difficulties in controlling public finances, the rising pace of short-term government debt issuance, falling commodity prices and real exchange rate appreciation cast increasing doubt on Russia’s debt servicing capabilities in late 1997 and the first half of 1998. As a result, the exchange rate suffered repeated attacks which were met by successive increases in interest rates to 150% by end-May... To buttress rouble stability, which had been a centrepiece of monetary policy for some years, a two-year international financial package of almost $23 billion was offered to Russia in July... However, given strong parliamentary opposition to key revenue-raising measures, implementing IMF’s adjustment programme proved difficult… Reserve losses continued and an attempt to lengthen the very short-term maturity of marketable government debt effectively 1 Banking Studies Section, Swiss National Bank. The opinions expressed are the author’s and do not necessarily reflect those of the Swiss National Bank. 349 failed, leaving almost $20 billion of short-term rouble debt to be financed before the end of the year. In addition, equity prices reached new lows, domestic interest rates stayed high, and spreads on Russian eurobonds reached 2,000 basis points. Faced with mounting domestic and external financing problems, the Russian authorities announced a radical policy shift in mid-August 1998. The main measures included the widening and subsequent abandonment of the exchange rate band, the suspension of trading in treasury bills combined with a mandated restructuring of government debt, and a 90-day moratorium on the repayment of corporate and bank debt to foreign creditors.” In September western banks began discussions with Russia on the debt restructuring, with agreement on the general principles of the restructuring reached in November. In December, however, western creditors rejected the Russian rouble debt deal, and Russia announced the terms of the debt restructuring unilaterally. “By end-1998, Russia was failing to meet payments on its more than $100 billion foreign currency debt inherited from the Soviet Union.” A parallel chronology can be established for international banks’ announcements on their exposure, losses and provisioning vis-à-vis Russia. As far as Swiss banks are concerned, UBS announced on 25 August a net exposure of $0.4 billion and trading losses of $0.2 billion. On 26 August Credit Suisse Group (CSG), the parent holding company of Credit Suisse First Boston, acknowledged that Russia’s problems would weigh on its profits, after rumours had circulated among traders about its Russian exposure. On 9 September CSG announced an exposure of $2.2 billion and provisioning of $1.1 billion. By combining the BIS survey with information from Reuters archives, we obtain a list of “key events” related to the Russian financial collapse. Table 1 recapitulates these events with an indication of their expected impact on Swiss bank stocks. Table 1 Events surrounding the Russian moratorium Date Event Expected Date Event Expected (1998) impact (1998) impact 26.5. TB interest rates up by 23% – 27.8. Worst depreciation of rouble – (27%) 27.5. Discount rate tripled to 150% – 31.8. Duma rejects Chernomyrdin ? 14.7. TB interest rates down by +9.9.CSG details exposure and – 135% provisions 11.8. TB interest rates up by 74% – 10.9. Yeltsin nominates Primakov ? 14.8. Several Russian banks default – 17.9. Talks between banks and + on interbank payments Russia on TB 17.8. Moratorium, government – 20.11. Agreement in principle + abandons rouble floor between Russia and creditor banks 20.8. Rumours about CSG’s – 25.11. IMF criticises Russia’s – exposure reforms 25.8. UBS announces net exposure ? 10.12. Banks reject debt – and $0.2 billion loss restructuring 26.8. CSG says Russia’s problems – with weigh on profits Source: Reuters. We expect increases in Russian treasury bill (RTB) interest rates and in the central bank discount rate to have a negative impact on bank stocks, as they reflect the pressures on the rouble exchange rate as well as investors’ preoccupations concerning Russia’s debt servicing capabilities. The moratorium announcement, if not anticipated by investors, may also depress bank stock returns. Likewise, we expect the failure of several Russian banks to have a negative impact on Swiss bank stocks, as this 350 event made it clear that the Russian banking system was seriously hit by the adverse developments on the RTB and rouble markets. Concerning the negotiations between Russia and its creditor banks, we expect the start of the talks and the announcement of an agreement in principle to have a positive impact on Swiss bank stocks. The banks’ rejection of the terms of the debt restructuring, conversely, may have affected bank stocks negatively as it destroyed hopes of a rapid resolution of the crisis. We make no a priori assumption about the impact of Russian political events such as Chernomyrdin’s rejection by the Duma and Primakov’s nomination by President Yeltsin. Concerning news on Swiss banks, we expect the rumours about CSG’s Russian exposure and the announcement by CSG of its substantial losses in Russia to negatively affect bank stock returns. UBS’s announcement of its fairly small Russian losses, conversely, may be considered as good news and we expect this event to affect bank stock returns positively. 3. Database and methodology 3.1 Database The data sample covers all Swiss-domiciled banks whose equity is traded on the Swiss stock exchange. We distinguish three bank categories: big banks, cantonal banks and foreign or investment banks. 3.2 Event study methodology We apply event study methodology to determine the magnitude of the stock market reaction to events related to Russia’s moratorium. Following Cornell and Shapiro (1986), we use two measures of return.2 The first measure is the excess return as estimated from the capital asset pricing model (CAPM). The second measure is simply the raw return. The excess return approach has the advantage of relying on a theoretical basis. Its results, however, are sensitive to the choice of risk-free asset and market index. The raw returns approach does not rely on a theoretical foundation, but it has the advantage of avoiding the aforementioned choices. 3.2.1 Excess return approach We begin the event analysis based on excess returns with an estimation of the CAPM equation: = − + βˆ ⋅ − + ε ERi,t Ri,t (R f ,t i (Rm,t R f ,t )) i,t where Ri,t is the daily return on the stock of bank i on day t, Rm,t is the daily return on the stock market 3 (Swiss Performance Index) on day t, Rf,t is the daily return on the risk-free asset (Confederation debt 4 register claims) on day t, i is the beta of the stock of bank I, and i,t is an error term. Excess returns for each bank or portfolio i are calculated for each event day as the difference between the observed return and the expected return: = − + βˆ ⋅ − ERi,t Ri,t (R f ,t i (Rm,t R f ,t )) 2 See Copeland and Weston (1983), pp. 319–27, for an introduction to event study methodology. A third approach consists in regressing observed returns on an intercept and on a market index in order to obtain “abnormal returns”. See Musumeci and Sinkey (1990) and Docking et al.

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