Welcome to another issue of Net Interest, my newsletter on financial sector themes. This week, the subject is Credit Suisse. The bank is in the process of resetting its corporate culture after a series of mishaps and I look at some of the challenges of that. Paid subscribers also have access to additional content on breaking themes in the weekly More Net Interest section.

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Creating a Culture: The Case of Credit Suisse

My bridge teacher is called Bridget. Needless to say, she was given her name years before she took up the game of bridge, so her choice of profession is either a strange coincidence or it’s destiny.

Turns out, this is quite a common phenomenon – it’s even got a name: nominative determinism. In 2015, researchers found a disproportionate number of Farmers in farming, Bakers in baking and so on, across a range of different occupations. Another team of researchers analysed the specialisations chosen by medics and found an uncanny overlap there. Around one in sixty specialists in urinary medicine have names like Burns, Cox and Ball. 1

It happens in finance, too. Barclays’ co-head of investment banking used to be called Rich Ricci until he was given a £44 million payout to leave the bank. The chief risk officer at Hargreaves Lansdown, a UK investment advisor, is called Shawn Gamble. And at Credit Suisse, a new chief risk officer was hired at the beginning of the year: David Wildermuth. Wildermuth is German – it means “wild courage”.

David Wildermuth made his debut presentation to investors this week and he didn’t hold back. In an environment where most banks are taking off risk, he took a different line: 

“We have the capacity to increase our risk… And it’s funny – it’s probably the second time in my career that I feel I’m as much a cheerleader for taking on more risk as I am for reducing risk.”

Given the backdrop, that’s a wildly courageous position to take. Bloomberg reports that in bond markets, the biggest global banks including Citigroup, Deutsche Bank, Goldman Sachs and JPMorgan are actively reducing risk. “Every bank is telling their traders not to make a single mistake, and to avoid that, they’re taking zero risks,” said one market participant.

But Credit Suisse is different from other banks. It was forced to take risk off at the tail end of a raging bull market as it addressed risk failings that popped up one after another. As a prelude to his cheerleading remark, Wildermuth provided some context: “Given the catastrophic events that occurred, I think it’s quite natural that the bank took a pause to sort of relook in depth at the overall risk profile of the portfolio. And while it was doing that, the risk pendulum did swing a bit to the conservative side.”

We’ve talked about two of those catastrophic events here in the past: Archegos in April last year and Greensill the month before. In both cases, Credit Suisse lost lots of money doing business it should never have done. Since then, other catastrophic events have emerged:

• In October last year, the bank agreed to pay $475 million in fines and forgive $200 million in debt owed by Mozambique to settle the long running “tuna bond” corruption scandal that rocked the country.

• In February, news organisations leaked details of thousands of Credit Suisse private banking accounts, including several held by clients linked to corruption.

• And this week, Credit Suisse became the first Swiss bank to be found guilty of a corporate crime after a court found it failed to stop the laundering of Bulgarian drug money. One of the bank’s relationship managers regularly collected suitcases of cash worth more than €500,000 from clients, including one who was shot dead outside a restaurant in Sofia. “The company could have prevented the infringement if it had fulfilled its organisational obligations,” said the judge, commenting on the “passive” role Credit Suisse played overseeing its relationship manager’s behaviour.

One measure of its exposure to catastrophic events over the years is the cumulative litigation expense Credit Suisse has incurred – over $12 billion since 2012. On top of that, the bank has provided for a further $2.5 billion and estimates another $1.5 billion of reasonably possible loss. In the past ten years, for every $100 of revenue it has earned from clients, it has had to disgorge almost $5 of that via penalties and fines, more than any other bank in Europe except Deutsche Bank and NatWest (RBS). 

Credit Suisse’s response to the latest revelations is that they are historic and that compliance procedures are now much more robust. The tuna bonds stem from a 2013 deal for Mozambique to borrow from international investors; the leaks relate to accounts that were opened as long ago as the 1940s; and the Bulgarian money laundering took place between 2004 and 2008. “Please be assured that we have taken action,” declared the group’s chairman Axel Lehmann in his annual presentation to shareholders in April. (Shareholders better hope that his name is not nominatively deterministic). 

But it’s hard to change a firm’s culture so quickly. Indeed, the UK’s Financial Conduct Authority doesn’t think that Credit Suisse has done enough to improve its culture, governance and risk controls – it recently added the bank to a watchlist of institutions requiring tougher supervision. Lehmann concurs that it takes more to overhaul a culture than replacing some personnel. “It has become clear that the challenges of the past were not solely attributable to isolated poor decisions or to individual decision-makers. Within the organisation as a whole, we have failed too often to anticipate material risks in good time in order to counter them proactively and to prevent them.”

So how do you change a culture in banking and what is it about Credit Suisse’s that exposes it to so much catastrophe?

One-Firm Firm

Back in 1985, David Maister, a former Harvard Business School professor, wrote an article for the Sloan Management Review questioning what makes some professional services firms more successful than their peers. He picked out McKinsey in consulting, Goldman Sachs in banking and Arthur Andersen in accounting. Andersen is no more, but what is interesting is that nearly forty years later, the other two firms are still at the top of their game. 

Maister’s argument is that these firms embrace a “one-firm firm” management system. “The characteristics of the one-firm firm system are institutional loyalty and group effort. In contrast to many of their (often successful) competitors who emphasise individual entrepreneurialism, autonomous profit centres, internal competition and/or highly decentralised, independent activities, one-firm firms place great emphasis on firmwide coordination of decision making, group identity, cooperative teamwork and institutional commitment.”

He goes on: “Members of these firms view themselves as belonging to an institution that has an identity and existence of its own, above and beyond the individuals who happen currently to belong to it. The one-firm firm, relative to its competitors, places great emphasis on its institutional history, broadly held values and a reputation that all actively work to preserve.”

When Maister developed that framework, Credit Suisse was anything but a “one-firm firm”. It conducted its Swiss banking operations through one business, SKA, and maintained various ancillary interests through a sister company, CS Holding (although it did hire McKinsey to help it set the thing up). One of those interests was a 25% stake in a joint venture with Wall Street firm, First Boston, which it had held since 1978.

Through the 1980s, the joint venture worked well. Credit Suisse (or SKA as it was known) looked after the Swiss market, First Boston looked after the American market, and the joint venture – CSFB – was responsible for Europe and the rest of the world. Across the three groups, the franchise became a top three player in M&A and established leading positions in equity and debt underwriting, with market shares of 11-15% and 9-15% respectively. 

However, as markets increasingly globalised, the three groups started treading on each others’ toes. In 1988, they were merged into a single firm headquartered in New York, in which Credit Suisse took a 45% stake (employees held 25% and institutional investors 30%). One year later, disaster struck. CS First Boston had become a leading player in the junk bond market. In 1988 it was ranked #2, behind Drexel Burnham Lambert. When the market collapsed, CS First Boston was left holding $1.1 billion of paper it couldn’t shift. With the firm’s future in doubt, Credit Suisse was forced to bail it out, taking majority control and slashing its headcount and balance sheet. 

CS First Boston never really recovered. Although it was run autonomously, it didn’t get the resources – either capital or staff budget – that other firms did. Staff defected in droves. Having been a top 3 player in M&A and underwriting in the 1980s, the firm slipped to top 5 in the 1990s. It had its licence revoked in Japan following misconduct there and suffered huge losses in Russia. To restore its position, Credit Suisse acquired parts of Barclays’ investment banking business in 1997 and poached teams from other firms, including Frank Quattrone’s tech banking team from Deutsche Bank, often on special profit-share schemes. In 2000, it acquired Donaldson, Lufkin & Jenrette for around $11.5 billion. The DLJ acquisition turned out to be one of the most expensive in investment banking history; sixteen years later its goodwill was finally written off. 

Why a Swiss private bank needed to own an investment bank at all is a moot point. Former chairman Rainer Gut laid out the thinking to shareholders back in 1989. He argued that it allowed the company to satisfy a wide variety of customer needs from under the same roof, while improving the spread of risk and encouraging initiative in business policymaking. But his strategy was the complete opposite of the “one-firm firm”. Private banking, investment banking and other businesses were given a great deal of autonomy, their different corporate cultures allowed to develop independently. 

It wasn’t until 2005 that management decided to meld the distinct parts of the business together in pursuit of a “One Bank” strategy, although the emphasis was more on short-term profit than long-term culture. The First Boston name was dropped and the group rebranded (leaving me the proud owner of a heritage Credit Suisse First Boston gym bag). Management estimated that the strategy would release 1 billion Swiss Francs of net profit synergies by 2008 on top of 8 billion Swiss Francs of underlying profit.

Unfortunately, the years that followed didn’t provide the most conducive environment for an internal restructuring. Instead of posting synergies in 2008, the bank posted a $2.85 billion writedown on collateralized debt obligations. It seems that a group of traders didn’t get the memo about actively working to preserve the firm’s reputation. One of them pleaded guilty to fraudulently inflating the value of mortgage bonds as the housing market collapsed, becoming the only banker in the US to be sentenced to jail time as a result of the crisis. “Why did you do that?” asked the judge. “To preserve my reputation in the bank at a time when there was great financial turmoil,” the trader replied.

Institutional Memory

Maister recognised that even after an organisation has embraced the ideal of a “one-firm firm”, sustaining the culture is hard. He identified a number of management practices to deploy. The best firms take training seriously; they “grow their own professionals” rather than make significant use of lateral hiring; they avoid mergers; they pursue a controlled growth; they are more selective than their competitors in the type of business they pursue and the clients they take on; they invest in research and development; turnover is carefully managed; compensation systems are designed to encourage intra-firm cooperation; and communications are open. 

It’s a useful checklist – many of the elements border on obvious – but it’s one Credit Suisse chose to ignore. The official review into the Archegos saga concluded that a new divisional head had just been appointed “with no background or training in leading an in-business risk function.” Turnover was high – “as employees left…they were replaced with less experienced personnel” – and the business failed to invest in necessary risk technology. In addition, reporting and communication lines were blurred: the prime services division that oversaw the Archegos account was run by two co-heads, each of which thought the other was on duty. 

Since Archegos, Credit Suisse has adopted more of Maister’s best practices. It has become more selective in the type of business it pursues, reducing the amount of capital allocated to investment banking, as well as the types of client it takes on. At this week’s investor presentation, the bank’s head of wealth management confirmed, “we’ve reviewed our client relationship for the high-risk clients and took a number of de-risking measures” (raising the question why this didn’t happen sooner). 

One recommendation Credit Suisse wasn’t able to implement was to “grow its own professionals”. Although it’s a positive development that the firm now has a new chief risk officer in David Wildermuth, the firm did have to recruit him from outside – he’d spent 25 years at Goldman Sachs where he was deputy chief risk officer (his boss at Goldman has been there for 28 years). 

Like Axel Lehmann at the annual general meeting, David Wildermuth reiterated this week that elevating a culture is a process. Institutions have memories that can be deep seated and so an overhaul takes a lot of time and energy, which can be hard to mobilise, particularly when the day-to-day is so volatile. 

One option is simply to close the investment bank and create a simplified “one-firm firm” around the wealth management business. A former CEO of Credit Suisse once said that you don’t need to buy a cow if all you want is a glass of milk; other firms are available to provide the services clients may need. Since around 2015, the group has in any case been downscaling its investment banking business. The trouble is, there are costs associated with winding down an investment bank. Cutting around 40 billion Swiss Francs of risk-weighted assets between 2015 and 2018 cost the bank around 5 billion Swiss Francs. There are around 85 billion Swiss Francs of risk-weighted assets left, with 13 billion Swiss Francs of capital tied up. Pulling it out could get messy.

So Credit Suisse will likely press on. There will be ups and downs – and the second quarter was a down, with the group pre-announcing a loss – but underlying cultural change takes a lot more than the injection of some wild courage. 

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