Why is Credit Suisse in trouble? The banking turmoil explained

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This week, stress in the U.S. banking system spread to Europe, making things worse for Credit Suisse, which was already in trouble.

The European lender has had trouble for a long time. But on Wednesday, the problems with the bank became very clear. After a crazy 24 hours in which the bank’s stock price dropped a lot and there were worries about financial contagion, Credit Suisse said it would borrow money from the Swiss central bank to improve its liquidity.

Here’s what you need to know about what happened to Credit Suisse and what could happen next.

What is Credit Suisse? That’s the first question.

Credit Suisse, which is based in Zurich and is pronounced “Credit Swees,” has been around since 1856, when it was started to help pay for the expansion of Swiss railroads. It is now Switzerland’s second-largest bank in terms of assets, after the UBS Group.

The bank’s main job is to handle money and make investment products for rich people all over the world. Credit Suisse has been trying to move on from a long string of scandals and quarterly losses by separating its investment banking division.

What went wrong this week at Credit Suisse?

After Silicon Valley Bank in California went down quickly last week, investors have been on high alert for signs of a chain reaction. Shares of banks all over the world, including Credit Suisse, went down because of this.

But things got worse for the Swiss bank on Wednesday, when its biggest shareholder, Saudi National Bank, said in an interview with Bloomberg TV that it wouldn’t be adding to its investment because of rules. 9.9% of Credit Suisse is owned by the Saudi National Bank. Most of the time, banks can’t own more than 10% of another bank because of capital requirements.

How did investors react to the statement from the Saudi National Bank?

It couldn’t have come at a worse time. Investors were already worried about other parts of the financial system that might be weak. The comments made them even more worried about the bank’s ability to make money and made it more likely that it might need to get money from shareholders again.

Investors rushed to buy so-called “credit-default swaps” to protect themselves from a possible Credit Suisse default. At the same time, shares of the Swiss bank fell by 24% on Wednesday, which was the biggest drop in a single day in recorded history. The prices of its bonds dropped to a very bad level.

Trade Alert, a company that collects data, says that traders rushed to buy Credit Suisse options. This was the most activity in recent years. Put options, which are bearish contracts that usually make money when a stock goes down, were more common than bullish call options.

Clients and government officials were keeping a close eye on Credit Suisse. People who know about the situation say that the European Central Bank called the banks it oversees to ask about their ties to Credit Suisse. The Wall Street Journal said that some of the bank’s clients stopped trading with the bank.

After the market panic, what happened?

After the end of trading in Europe on Wednesday, Swiss regulators said they would help Credit Suisse get cash if they needed to.

Within hours, Credit Suisse said it would use the Swiss National Bank’s offer of more than $50 billion to stay in business. That made the stock price of Credit Suisse go up on Thursday, and other European banks followed suit. Analysts said that Credit Suisse might not need the money after all. Instead, the company borrowed the money to show investors that they could get cash quickly.

Dan Davies, who is in charge of research at Frontline Analysts, said that it is unlikely that the bank will use the facility to pay for operating costs. It has used the help to buy liquid securities that could be sold quickly if the bank ever needed cash. This has helped the bank’s balance sheet, he said.

“They mostly have that so they can wave it around and tell everyone, ‘Look at how strong our liquidity ratio is,'” he said.

Jérôme Legras, head of research at Axiom Alternative Investments, said it was likely meant as a show of force to investors who shorted Credit Suisse stock or sold credit-default swaps to protect against default.

Does Credit Suisse still make some investors nervous?

Yes. The troubled bank’s assets continue to show signs of stress, which makes investors nervous.

Credit Suisse stock dropped almost 7% in Switzerland on Friday, which means that it has lost about a fifth of its value this week. In the meantime, the prices of Credit Suisse bail-in bonds, which are worthless if the bank gets into serious trouble, haven’t changed much.

Investors also keep buying insurance against the bank not being able to pay some of its debts. The cost of insurance against default on five-year Credit Suisse senior debt is twice what it was at the beginning of the week.

How long ago did Credit Suisse start having trouble?

Since a long time ago.

The bank has been through a time when there were market crises, changes in management, and financial losses. It lost a lot of money because it had ties to Greensill Capital and Bill Hwang’s Archegos Capital Management, both of which went bankrupt. The collapse of Archegos cost Credit Suisse $5 billion in 2021, which was equal to more than a year’s worth of profits.

In recent months, customers have been taking money out of the bank. Credit Suisse executives say that in October, the bank lost a lot of wealthy clients because of a social media storm about the bank’s health.

The withdrawals didn’t stop until the end of the quarter, so the bank called more than 10,000 wealthy customers to reassure them that the bank was still in good shape.

Last year, deposits fell 40% to 234 billion Swiss francs, which is about $252 billion, and total assets fell 30% to 531 billion francs, which is about $571 billion. This is because, among other things, the bank was cutting back on its businesses. Credit Suisse had a net loss of 7.3 billion francs in 2022. The year before, it had a net loss of 1.7 billion francs.

Last year’s outflows were already scary for investors. “Their investors and people who have money on deposit with them have been kind of on edge about this,” said Octavio Marenzi, the head of the consulting firm Opimas.

He said that his clients in wealth management are very careful investors with a lot of money who started to worry when things didn’t go as planned. “It’s been a slow process, but CS has finally reached a breaking point and a tipping point.”

What’s different about Credit Suisse from Silicon Valley Bank?

Most of the people whose money Credit Suisse manages have millions of dollars to invest. The bank’s biggest clients are billionaires and sovereign-wealth funds. Most of its loan portfolio is in Switzerland, which is very conservative. There, it is the No. 2 bank by assets and serves savers and businesses. It also has big parts that deal with investment banking and managing assets.

Global regulators think of it as a systemically important bank because of its size and the way it fits into the financial system.

Silicon Valley Bank was a local bank that worked with venture capitalists and new technology companies in the United States.

As is common in the industry, Credit Suisse has made bets to protect against rising interest rates. At the end of 2022, Silicon Valley Bank’s huge bond portfolio had almost no interest rate hedges.

What will happen next?

Analysts at JP Morgan said that even though Credit Suisse doesn’t have a capital problem, it still has problems with how the market trusts it. The U.S. bank gave the bank three possible ways things could go:

The bank stays on its own as a lender. It shuts down its investment banking division and raises money through a partial IPO of its Swiss business. But it’s not clear if Credit Suisse has enough time to carry out this plan.

The Swiss National Bank steps in and backs up all deposits, or it gives Credit Suisse money, though tapping taxpayers may not be a good idea these days.

The bank is taken over by another company, which could be Swiss rival UBS.

What effects do the problems at Credit Suisse have on the global banking system as a whole?

Credit Suisse is an important part of the global financial system because it works closely with many banks and institutional investors. Investors said that some of the drop in European banking stocks this week was due to fears of a chain reaction.

On a larger scale, the problems at Silicon Valley Bank and Credit Suisse have made investors think that the Federal Reserve might stop or slow down its plans to keep inflation under control by raising interest rates further.

Source: Team CurrencyVeda