UBS has agreed to purchase Credit Suisse in an all-share deal for USD3.25bn, which was brokered by the government. This deal is the largest bank merger since the global financial crisis and will result in a combined entity with a balance sheet of USD1.7trn, placing it among the top 10 global banks in size. However, the complete write-down of Credit Suisse’s USD17.3bn worth of additional Tier 1 capital is unusual but legal. Shareholders, who usually rank junior, still received some stock in UBS at a premium, contrary to the conventional bail-in hierarchy of banks’ capital structure. This specific write-down of hybrid capital instruments is unique to the two large Swiss banks, with other European banks issuing AT1 instruments that make the write-down temporary or covert into equity, limiting potential spillover effects to the hybrid capital market. Although European banks appear to be well-protected, funding and capital costs are expected to increase, leading to a market repricing and readjustment. Despite this, financial stability concerns will influence but not determine the policy rate path forward. While banking-sector tremors have already tightened global financing conditions, they will not do so quickly enough for the Federal Reserve and the ECB to abandon their restrictive stance. Therefore, central banks’ initial response to financial-market stress is to provide ample liquidity, with the preferred option being to wait for inflation to slowly decrease on the back of the lagged effects of monetary policy, without causing dislocations in capital markets.

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