Will Credit Suisse trigger another global financial crisis?

 

The Story

Credit Suisse is a famous investment bank headquartered in Switzerland. It’s been around since 1856 and it’s one of the biggest banks in the world.

But many people believe that the bank may now be under considerable financial distress and they are predicting a total collapse of the entire global banking system.

So the big question is — How did we get here and is there any merit to these allegations?

Well, there are a few concerning developments. One, the company’s share price has been tanking rather precipitously. They fell around 10% in early trading just yesterday and the price has collapsed nearly 50% in the past 6 months.

Next, there’s the issue with Credit Default Swaps. We won’t get into the technicalities here, but a bank like Credit Suisse has to borrow money to keep doing business. But lenders don’t always automatically assume that they’ll get paid in full. Instead, they may find ways of protecting themselves against an extraordinary default event, by buying a credit default swap (CDS). It’s like insurance, only the provider will pay the lender if Credit Suisse defaults on its obligations. Now if you look at the premiums being quoted on these products, you can tell if there is a real risk of default. For instance, if a third party tells you that they will insure you against a default, only if you pay a ludicrously high premium, then you could potentially argue that Credit Suisse may go under.

That’s why they’re charging you that much.

And right now, the premiums on Credit Suisse CDS’ are off the charts. Even higher than the figures being quoted back in 2008 when everyone thought that the banking system would collapse under its own weight.

But yesterday, the CEO made a statement to assuage these fears. He said, and we quote:

“I know it’s not easy to remain focused amid the many stories you read in the media — in particular, given the many factually inaccurate statements being made. That said, I trust that you are not confusing our day-to-day stock price performance with the strong capital base and liquidity position of the bank.”

But the statement didn’t do much at all. In fact, people began pointing out that this statement sounded eerily similar to what Lehman’s CFO said 14 years ago about their capital position. This was back in September 2008 right before the bank went kaput.

Even Nassim Taleb, the famous author and trader weighed in on the matter and tweeted: “All rumors are false until officially denied.” His point being that if the top executive at one of the world’s biggest banks has to categorically deny such rumours, it doesn’t assuage any fears.

But outside of the rumours, there’s also some real concern about the bank’s financial position.

Let’s start with failures in risk management. When you have a massive investment banking division like Credit Suisse, it’s imperative you deploy capital (money) in a manner that’s prudent. This explains why global banks such as Credit Suisse will have entire departments dedicated to risk management. But over the past few years, the bank seems to have made increasingly reckless decisions.

Take for instance the Greensill debacle. They were the largest non-bank provider of supply chain finance. And in a bid to service clients across the globe, they borrowed large sums of money from outside investors. Outside investors including Credit Suisse. Credit Suisse, in turn, convinced its customers to deploy large amounts of capital — $10 billion in fact. And when Greensill went bankrupt, both the bank and its clients suffered in tandem.

There’s also the infamous Archegos Capital fiasco. Here, a family office decided to gamble large amounts of money in picking risky stocks and eventually lost it all. However, since they financed these trades using money borrowed from Credit Suisse, the bank also had to take a massive hit.

They also paid nearly $275 million to settle legacy issues with regulators across the US, UK and Switzerland last year. And this hasn’t helped matters either. Then there’s a general slowdown in the investment banking arena. There aren’t enough Mergers, Acquisitions and financing activities going around. Meaning Credit Suisse doesn’t have as many avenues to work these deals and boost income.

All this is increasing its cost of capital. The bank is being forced to pay a higher cost on its borrowing and it’s affecting its bottom line. This explains why the bank has posted a loss every single time during the last 3 quarters.

And the general expectation is that the bank may find itself in a tough spot soon enough. They are losing top talent. Their restructuring plan (to hive off the investment banking division into three parts) hasn’t gone down well with investors. And there’s some concern on whether the bank is adequately capitalized i.e. if they have the money to tide over their obligations.

If they don’t, they could potentially default. And a default won’t go down well with anybody. Because Credit Suisse doesn’t operate in a vacuum. It’s connected to the worldwide banking system. It is systemically important. Meaning its collapse could trigger a collapse of the entire banking system.

Will it happen?

Well, we don’t know. But we hope and pray it doesn’t come to that. Because the last thing this world needs is another global financial crisis.

Until next time…

If you learnt something new, why not share it with your friends? Share this story on WhatsApp, LinkedIn and Twitter