Credit Suisse: The Run
Musings About Trust in Banking (III)
The NZZ began its tribute to Credit Suisse with a view on its birth hour “It all started with a run on the bank. Or more precisely: its shares”. In the economic boom year of 1856 people desperately wanted to get one of the first issued 9000 shares. 165 years later it ended — with another bank run, this time one for good. But what exactly is a bank run? A bank run occurs when a large number of depositors simultaneously withdraw their funds from a financial institution, causing a liquidity crisis. While many commentators attribute a loss of trust as the reason for such an event, the question remains: what can we learn from trust research about bank runs? Furthermore, why is it crucial to acknowledge that the loss mainly stems from a sense of false control, referred to as confidence, and that a lack of calculative trust in the regulatory system speeds up the run? Finally, what is the role of goodwill trust in a specific bank and its representatives leading to and from such an event? While I will share my perspective, a complete picture requires input from risk and finance specialists.
A Loss of Confidence Punctuates False Control
In trust research, a clear distinction is made between confidence and trust. Confidence refers to the absence of perceiving a risk; a state where individuals are assured that their expectations will not be disappointed. When we are confident, we do not consider the possibility of being unable to withdraw money from an automatic teller machine or the potential complete loss of value of the shares we have purchased. Trust, on the other hand, involves a prior engagement and requires a willingness to take on risk. It presupposes a situation of risk and can lead to a risky investment, where individuals decide to trust despite the possibility that their expectations could be disappointed.
In the literature that examines the psychological factors behind bank runs, the false sense of control that comes with excessive confidence is often identified as a significant contributor. This confidence, which can be reinforced by individual attribution biases, such as the beliefs that success is due to own skills whilst failure is attributed to bad luck, and contagion effects, can lead investors and bank customers to believe that their money is safe in a bank. However, when events unfold that challenge their sense of control, panic can ensue. This emotional response is a natural and protective reaction to the realization that important financial outcomes are no longer predictable or controllable, and can be triggered by the rupture of overconfidence. For example, the perception of Switzerland as a safe haven for money can create a false sense of security that is shattered when a banking crisis occurs.
When Confidence Breaks Down, Calculative Trust in Institutions Must Take Over
The sensation of panic experienced during a bank run triggers our fight or flight response, which is further intensified by social factors such as observing others in a state of panic, the spread of anxiety through social media, and nervous statements from politicians. However, during these episodes, our trust in the financial system becomes critical. A loss of confidence leads us to question our trust in the system — can we willingly accept the risk in this situation? Are there any indications that the systems put in place to align our interests with those of the bank are functioning? We begin to calculate and develop what is referred to as calculative trust. Calculative trust is largely dependent on effective controls (and clever incentives) — we strive to assess whether the liquidity provided by central banks is sufficient, investigate whether the promises made by politicians to offer a safety net are trustworthy, and evaluate the credibility of financial regulatory bodies. However, whether or not calculative trust can withstand our initial shock is determined by the level of trust established in the past and the decisive measures taken at the right moment.
In fact, when Timothy Early, a risk researcher, analyzed the last major financial crisis, he reached an interesting conclusion. During the crisis, the former President of the Federal Reserve Bank, Alan Greenspan, advocated for a private solution that relied on relational (and mostly goodwill) trust-building efforts among economic actors. However, his successor, Ben Bernanke, recognized the need for calculative trust. Bernanke famously stated that “intervention to protect the public interest is not only justified but must be undertaken forcefully and without hesitation” when financial stability is broadly threatened. Bernanke assured the American people that all available resources would be utilized to address the crisis, including historical understanding, technical expertise, economic analysis, financial insight, and political leadership. As a result, he focused on ensuring the technical functionality of the financial system and implementing regulations to ensure its continued operation by the state.
The Role of Trust — Before and After a Bank Run
Where does this leave us with specific trust, or more precisely with goodwill trust — the type of trust that relies on expectations of good intentions, the integrity of economic actors, and their at least minimal benevolence? Goodwill trust goes beyond calculative trust and is more often based on interpersonal trust than trust in a company, although we also attribute good character to abstract entities. Here, the core representatives, such as the CEO, play a crucial role in establishing our expectations. Such trust is essential as it enables us to take personal risks that would otherwise not be possible. It reduces control costs to some extent, although a basis of calculative trust is often still necessary. Goodwill trust also allows us to go beyond what rules, incentives, and controls can afford — it enables us to co-create or, in the case of banks, build businesses together. Furthermore, goodwill trust is more resilient, making it especially important in times of crisis as it enables us to bridge the valley of tears together.
Often in bank runs and/or n sudden losses of investor confidence, such goodwill trust is already damaged beforehand, as was the case with Credit Suisse. As I have discussed in my previous articles, various scandals, unclear and unprofessional communication, and a lack of managerial and technical competence have contributed to a skeptical and suspicious view of the bank. If a global loss of confidence is then triggered, even if it originates in a faraway place like California, there is no trust credit left to buffer the situation. Only calculative trust can remedy such a situation. This brings us to the question of whether Switzerland reacted correctly. Was the Swiss National Bank firm enough, and should it have issued the covered loan facility earlier, and at a higher amount? Were the regulatory efforts of the Swiss Financial Authorities strong enough, and were the regulations strict enough? And what about the Finance Minister? Could she have issued a clearer and more forceful signal that every issue was being addressed to tackle the crisis?
Why Financial Actors Need to Understand and Master Confidence, Calculative Trust and Goodwill Trust
Although it may seem confusing at first glance, it is important to understand the various trust-related factors that contribute to the smooth functioning of the banking sector. These conditions must be built and maintained differently, each with its advantages and pitfalls. It is essential for bankers, regulators, and politicians to have a comprehensive understanding of these factors:
Learnings from Lesson 3
So what are the learnings for the actors in finance from a trust perspective?
- The state has the primary responsibility for ensuring calculative trust. This requires good regulations and adequate resources to implement them. The idea that “the market will take care of itself” is misplaced when it comes to the banking sector.
- Additionally, banks need to find better ways to ensure their technical competence. Merely completing tick-box exercises is insufficient. Perhaps we should start treating banks as high-reliability organizations with a “deference to expertise, reluctance to simplify, sensitivity to operations, commitment to resilience, and preoccupation with failure.”
- It is important for investors and clients to guard against excessive confidence. Behavioral finance has discussed herding effects and similar phenomena that can lead to dangerous dynamics.
- Goodwill trust needs to be built as a constant effort. See here my article on the role of the board of directors and what will follow in part 5 of this article series. It starts though with selecting and promoting humans with good character and practical wisdom…but that is a new story ;-)
Literature
Luhmann, N. (2000). Familiarity, confidence, trust: Problems and alternatives. Trust: Making and breaking cooperative relations, 6(1), 94–107.
Earle, T., & Siegrist, M. (2008). Trust, confidence and cooperation model: a framework for understanding the relation between trust and risk perception. International Journal of Global Environmental Issues, 8(1–2), 17–29.
Lewicki, R. J., & Bunker, B. B. (1996). Developing and maintaining trust in work relationships. Trust in organizations: Frontiers of theory and research, 114, 139.
Bracha, A., & Weber, E. U. (2012). A psychological perspective of financial panic. FRB of Boston Public Policy Discussion Paper, (12–7).
Weibel, A., & Six, F. (2013). Trust and control: The role of intrinsic motivation. In Handbook of advances in trust research (pp. 57–81). Edward Elgar Publishing.
Weick, K. E., & Sutcliffe, K. M. (2001). Managing the unexpected (Vol. 9). San Francisco: Jossey-Bass.
