Will the coronavirus-crisis become a direct threat to the global financial and banking system? The steps taken to support the system by central banks would suggest yes. But what are the key elements that could tip the scales?

The growing global spread of the new coronavirus has become a stress test for banking and the financial system. The dramatic drop of bank stocks are proof of this: UBS and Credit Suisse reached record lows on Thursday and the stocks of both banks have lost more than 30 percent within a month.

The concern about a substantial slowdown of economic growth because of the coronavirus isn't going to explain this type of drop alone though. It is much more a case of increasing worries about the onset of a new financial crisis – and central banks are doing their best to allay those fears with decisive steps, such as those taken by the European Central Bank (ECB) on Thursday. The bank's decision to ease conditions on long-term refinancing is very much viewed as a step to support the banking system.

But how substantial is the danger to banking in Switzerland and the global financial system? What are the elements that fuel such concerns?

1. How Stable Are Property Prices?

It is safe to say that major swings in the Swiss real estate market would turn into significant stress tests for domestic retail banks. The mortgage volume in Switzerland has doubled over the past 15 years and reached a total of some 1.1 trillion Swiss francs ($1.16 trillion). Residential housing has almost doubled in value over the same period of time.

What would happen if the coronavirus outbreak triggered a big drop in the prices of real estate? The outfall would be massive. The average percentage of capital homeowners have loaned has risen due to the slump in interest rates. In 2018, only 26 percent of the average house price was financed by homeowners themselves, the rest was put up by banks. A strong drop in valuations would force homeowners to inject additional capital. If they can't, their mortgages would be canceled. That, in turn, would pose a real danger for the stability of banks.

2. Will Small Businesses Bring Down the Banks?

Insiders such as ex-SNB-President Philipp Hildebrand identified the small- and medium-sized companies in Switzerland as an Achilles heel of the financial system. If people can't move about anymore and if a recession reduces demand, the small business backbone of the economy will suffer and loans could turn into bad loans.

Swiss retail bankers say that most of their loans to small firms are backed up by property. And small businesses have done so well in recent years that they have adequate levels of cash to fall back on. This might help them in the coming situation, but a reality check will need to show whether this is really so.

3. What if Too Many Bankers Get Sick?

The Swiss banks that are too big to fail have to provide the regulator with a so-called «business-continuity-plan». It entails detail on how they can guarantee the operations of the bank and vital services for the economy in times of crises. Some Swiss banks have found it difficult to implement the split force-plans necessary to prevent the infection of entire, key teams.

So what if the covid-19 becomes more virulent? What if banks get sick and if plans fail? Banks would essentially be forced to stop operating. This would make the financial market very vulnerable to further shocks.

4. Swiss Bankers: Not Welcome

A 30-day travel ban to the U.S. set to go into force on Friday will hit Swiss banks directly: neither the CEO of UBS, Sergio Ermotti, nor Credit Suisse boss Thomas Gottstein will be allowed in. The decision will hit harder in the nitty-gritty: for example, UBS is in the late stages of hiring for and building out its ultra-rich business in the U.S. under Swiss veteran Josef «Joe» Stadler (banned from the U.S. right now). The co-head of its investment bank, Piero Novelli, won’t be able to get in; the same applies to UBS’ top lawyer, risk chief, and compliance boss. Should the month-long ban be extended, a minor inconvenience will turn into a major hassle – and business risk.

5. When Ratings Turn Ugly

During the financial crisis of 2008, rating agencies were late to see the true risks. With memories still fresh of that belated response, it is likely that Standard & Poor’s and Moody’s won't wait for too long before cutting the ratings this time around. The «Financial Times» has reported that the first companies already have been moved to a watchlist.

Swiss banks obviously aren't immune to downgrades, especially if economic growth is slowing substantially in Switzerland. A cut in their rating might be the trigger to cause more trouble still.

6. Bubbles Exist. When Will They Burst?

In 2008 it was derivatives that triggered the massive crisis. Only a few observers had seen the crisis emerge in the subprime segment. Today, it is well known where the problems lie. One such hotspot is the financing of takeovers through loans, primarily in the U.S. The valuations have increased steadily since the crisis. And with great amounts of money flowing into the private-market funds, prices have risen further.

If however, the companies in which the investments are made develop financial difficulties due to the fallout of the coronavirus, the valuations of the funds will evaporate.

In recent years, junk bonds were the investments with the highest return, and therefore, demand was huge. In 2019, the value of such assets on average increased by 13 percent. A recession may lead to downgrades and debt defaults in a big way. No wonder has the market been frozen in recent days.

Central bankers know how to deal with such bubbles, having dealt with the euro-debt crisis not so long ago. Provided they can generate enough cash, they should be able to deal with such hotspots.

7. Loss of Trust

The worst case is a loss of trust in the system, such as the one triggered by the demise of Lehman Brothers in September 2008. The repo market collapsed because banks no longer offered their available liquidity to rival banks.

Hence, the mutual trust was gone, with the fall of Lehman giving its rival Wall Street firms a taste of what was wrong with the system: not enough capital and no reserves. The repo market is a lifeline for banking and if there is no cash left, the worst-case scenario comes true.

Are banks facing such a scenario? The massive drops on the market may be a trigger. Securities often serve as collateral in the repo market. If the collateral is worth less, the lender can ask for more security. If a bank fails to provide such security, this could turn into a catalyst for a general loss of trust.