As you might have heard, Europe’s second-largest bank, Credit Suisse, is reportedly under severe financial distress. Many analysts are predicting a collapse of the entire global banking system as a result of its situation. In this article, we discuss the crisis brewing at Credit Suisse and its impact.
About Credit Suisse:
Credit Suisse Group AG was established in 1856 to fund the Swiss railway network. Headquartered in Zürich, Switzerland, the company provides private banking, asset management, and wealth management services. At the end of 2021, Credit Suisse reported over 1.6 trillion Swiss francs in assets and 50,000+ employees in the institution.
Why is it in Trouble?
Credit Suisse’s shares have declined nearly 60% since the beginning of 2022. Investor sentiment has fallen due to a series of losses and high-profile managerial malpractices! It made several risky bets and ended up losing a lot of investor money.
- For example, Credit Suisse convinced customers to invest up to $10 billion in Greensill Capital, which acted as an intermediated between suppliers and clients. It paid suppliers cash upfront and took their place in waiting for the clients to pay. This business attracted a lot of attention and money in its initial stages.
- However, in March 2021, Credit Suisse announced that it was closing and liquidating several investor funds provided to Greensill Capital. Greensill filed for bankruptcy, and investors reportedly lost $3 billion!
- During the same period, Credit Suisse lost nearly $5 billion when Archegoes Capital Management collapsed.
- In another instance, a massive leak of over 30,000 of Credit Suisse’s clients in February 2022 revealed over $100 billion in wealth held by people who had profited from “torture, drug trafficking, money laundering, corruption, and other serious crimes”.
- The bank has changed top leadership multiple times since 2019. They also paid nearly $275 million to settle legacy issues with regulators across the US, UK, and Switzerland last year!
The Issue With Credit Default Swaps
Currently, Credit Suisse’s corporate bonds are losing value. The premiums on their Credit Default Swaps (CDS) are very high. Let’s understand what this means:
Banks like Credit Suisse have to borrow large sums of money (via bonds) to conduct their regular operations. But lenders do not always automatically assume that they’ll get paid in full. So they use credit default swaps to limit their risk.
A CDS is a financial instrument that allows a firm to swap or offset its credit risk with another entity (similar to insurance). To swap the risk of default, the lender buys a CDS from a third party that agrees to reimburse them if the borrower defaults (or is not in a position to pay back). Since a CDS functions as a type of insurance, the buyer pays a premium to the seller (the third party).
So the premiums on Credit Suisse’s CDS have surged now, which indicates that the market feels these bonds are more likely of failing. If Credit Suisse can’t pay off its massive debts, its collapse could trigger a downfall of the global banking system as it’s all deeply interconnected.
What Next?
Earlier this week, Credit Suisse Group AG’s CEO Ulrich Koerner wrote a letter to the bank’s employees:
“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”.
Unfortunately, many analysts have pointed out that this statement is similar to the one made by Lehman Brothers’ Chief Financial Officer (CFO) in 2008, right before the bank collapsed and led to a global economic recession. Credit Suisse is now trying to repair the damage by strengthening its wealth management business and transforming its investment banking division.
Coming to the Indian scenario, most analysts feel that the Indian banking system is quite resilient to such threats. We could see an impact on cash flows and sentiments, and that can bring high volatility in the stock markets.
Let’s hope such a financial crisis doesn’t occur again. Do you have any views on the current situation of Credit Suisse? Let us know in the comments section of the marketfeed app.
