Can Credit Suisse lead to a new financial crisis on a global level?

Credit Suisse, one of the world’s oldest and most historically significant banks, has just seen its share price collapse to an all-time low. Credit Suisse’s share price has decreased by roughly 60% since the beginning of 2022. Credit default swap (CDS) spreads on Credit Suisse debt have also risen to their greatest level in 14 years, surpassing even those seen at the height of the global financial crisis in 2008. Many people, especially those on social media, have begun to wonder whether Credit Suisse is poised to fail, much as the venerable American financial bank Lehman Brothers did in 2008.How accurate is the online speculation on Credit Suisse? | Mint

What led to the worries over Credit Suisse?

A letter that Chief Executive Ulrich Koerner issued to Credit Suisse employees on September 30 appears to be the most recent spark. “I am aware that it might be challenging to maintain concentration when reading the countless items in the media, especially in light of the numerous assertions that lack factual support. Having said that, I hope you are not misunderstanding the performance of our stock price daily for the bank’s sound capitalization and liquidity position “He declared. According to reports, Credit Suisse had just over 50,000 workers and assets under the control of $1.62 trillion by the end of 2021.

Over time, the share price has decreased almost entirely. The reason for this is rather straightforward: Multiple hazard wagers made by Credit Suisse led to large investor losses. This has reduced investor confidence, hurt firm profitability, and raised the cost of borrowing fresh money.

For instance, Credit Suisse advised several clients to make investments in Greensill Capital totaling up to $10 billion. By acting as a middleman between suppliers and customers, Greensill served in a similar capacity to a lender. In other words, it replaced the suppliers’ role of waiting for payment from customers by paying suppliers upfront in cash. Thanks to institutions like Credit Suisse, the company garnered a lot of interest and capital.

However, there were growing concerns about Greensill’s capacity to maintain its financial stability. Greensill filed into bankruptcy in March 2021, hurting Credit Suisse and its wealthy investors. Bill Hwang’s hedge fund Archegos Capital Management failed in March 2021, costing Credit Suisse an additional $5.5 billion.

High-profile managerial errors and departures were interspersed with such losses, severely weakening investor trust. For instance, in 2020, the company’s former CEO, Tidjane Thiam, was forced to resign when it was discovered that he had been eavesdropping on Iqbal Khan, a wealth management executive at Credit Suisse.

Was there any effect on Credit Suisse?

The secular decline in the share price of Credit Suisse is a helpful indicator of how investors have progressively abandoned the venerable bank. Additionally, the cost of Credit Suisse’s bonds has declined, which has led to a pretty significant increase in their yields since fewer people desire to lend money to the company. Higher rates essentially imply that the bank would have to make bigger returns for each dollar or euro it borrows from the market.

This becomes an issue, especially given the current situation that the developed countries are in when central banks are hiking interest rates to fight inflation while growth prospects are deteriorating. A bank with declining profitability must obtain capital at quickly rising interest rates, but it will struggle if the market does not offer sufficient returns.Is Credit Suisse crisis a threat for Indian banking, stock market? - BusinessToday

The other equally alarming issue is the widening of credit default swap spreads. In essence, a CDS is a mechanism used in insurance. An investor who has loaned money to a corporation (let’s say Credit Suisse) but is concerned about the company’s ability to repay the loan can acquire a CDS on Credit Suisse’s bond. If Credit Suisse is unable to repay, a CDS ensures that the insurer will pay the amount.

The insurance company selling the CDS receives a specified interest as compensation. The spread of CDS is the name for this interest. These spreads indicate an increased likelihood that a specific bond may default when they increase. CDS spreads for bonds issued by Credit Suisse have risen to 14-year highs.

On October 27, Credit Suisse is anticipated to present a fresh strategy designed to change the way the bank operates and inspire investor confidence. Credit Suisse is now being reshaped for a long-term, sustainable future with substantial potential for capital generation. “I am convinced we have what it takes to succeed given the broad franchise we have and our long-standing commitment to serving some of the most successful businesses in the world,” Koerner stated in the memo.

Lending conditions have generally been tighter since central banks throughout the world started raising rates. Investors are especially afraid that the Federal Reserve’s aggressive actions will result in a harsh landing. Making matters worse, a severe recession is anticipated to be brought on by the impending winter energy shortage in Europe.

The radical unfunded tax cut proposal of British Prime Minister Liz Truss caused a collapse in the country’s currency and sovereign bond markets as a result of the extraordinarily sensitive market response. After hearing allegations that the market was taken off guard by the abrupt move and that pension funds holding $1.7 trillion in assets were almost at risk of being damaged, the Bank of England was obliged to agree to a $74 billion intervention.

As a result, the general mood in the capital markets is highly unstable, particularly when it comes to the banking industry. Unfortunately, when there are broader problems, the markets are eager to penalize the Swiss bank in particular, according to significant Credit Suisse shareholders like David Herro, portfolio manager at Harris Associates. This is because it has displaced Deutsche Bank as Europe’s main driver of instability in the region’s struggling banking sector.

During the last 18 months, the institution, dubbed “Debit Suisse,” has seen a rash of scandals and humiliating managerial exits, including those of the former chairman, Antonio Horta Osorio, and the former CEO, Thomas Gottstein.

The bank’s market capitalization has decreased to almost a fifth of its tangible book equity of 42.5 billion francs. Its shares are therefore priced at a significant discount to the entirety of Credit Suisse’s hard-recoverable assets, which may be sold to pay off the debt in the case of a collapse—typically a symptom of a severe financial crisis.

Although the record-high CDS prices for this asset class may be another sign of trouble, it’s important to remember that anybody may buy them. Hedge funds typically utilize excessive amounts of leverage to support their speculative wagers, which allows them to speculate on default whether or not they hold the underlying debt. Due to the potential for creating a perverse incentive for financial arson, experts usually equate it to buying insurance if your neighbor’s home catches fire.

Experts have frequently compared it to purchasing insurance if your neighbor’s home catches on fire since it can lead to a perverse incentive for financial arson. Credit Suisse has already put up its third restructuring plan since February 2020, when Gottstein took over leadership of the company, as the markets are agitated and its reservoir of trust is all but depleted.

According to market analysts, the banks have suffered as a result of the rapid rise in global interest rates, and the problems have become worse. They also claim that the pressure on the banking industry may cause interest rates to rise and the value of currencies throughout the world to shift. This will have a substantial impact on Indian equity markets, which will have an impact on equity mutual fund returns.

Following the Friday release of an internal email from new CEO Ulrich Körner, in which he assured colleagues that the firm had “a healthy capital basis and liquidity position,” Credit Suisse unintentionally made matters worse. Relying on assurances like these might be counterproductive and have the opposite psychological impact of what was intended. That turned out to be the case, unsettling markets instead of calming them, and Credit Suisse immediately dropped 12% at the start of the following trading day.

Real dangers to international investors

A potential wipeout of Credit Suisse shareholders would be shocking, but it could be possible in the long run if its repercussions are contained. The real threat to foreign investors is the cascading uncertainty that would arise if other lenders were forced to significantly reduce their obligations to their Swiss counterparts.Credit Suisse warns it is facing another loss in the second quarter - Financial News

Transparency on the risks that a bank is exposed to through its trading book is critical for determining contagion. The abundance of financial assets designed for custom bets that were so illiquid that banks could only evaluate those using unproven speculative pricing methods was one of the factors that led to the meltdown in 2008. When these turned out to be unsustainable, everyone was suspected since no one knew who had certain exotic derivatives.

Because they are unaware of who is on the other side of Credit Suisse agreements, markets that are already anxious are just buying more insurance against potential defaults elsewhere. As a result, CDS costs are rising at both Deutsche Bank and UBS.

When the bank releases its third-quarter results report on October 27, Credit Suisse CEO Körner is scheduled to discuss his restructuring strategy. The goal, it said last Monday in a statement to the markets, is to “establish a more focused, agile organization with a much reduced absolute cost base, capable of generating sustainable returns for all stakeholders and first-class service to customers.”

Since 2008, one thing has changed: Credit Suisse is now considered systemically significant and is subject to the strictest solvency standards imposed under Swiss banking laws. It must maintain a common equity tier 1 (CET1) equivalent to one-tenth of its total risk-weighted assets under legislation that has been updated to reflect lessons learned from the global financial crisis.

It has to hold around $10 in the tightest form of shareholder capital for every $100 it lends out to function as a loss-absorbing cushion. According to the most recent statistics available, its CET1 ratio at the end of June was 13.5%, showing that it had a high solvency ratio going into the current quarter. The question is how much of a diluted effect the new CEO’s restructuring plan may have. Even if the downward spiral of gradually declining trust in Credit Suisse has temporarily been stopped, Körner is nonetheless under immense pressure to do well after only two months in the job.

Should investors in mutual funds be concerned about the Credit Suisse crisis?

Losing or gaining more than 1,000 points on significant stock market indices like the Sensex or Nifty still has an impact on the bulk of mutual fund investors. Another problem is that recent extreme stock market swings have become the norm. It’s probable that global problems, including unchecked inflation, fast rate hikes, rising oil prices, and the likelihood of a recession, are making ordinary mutual fund investors, especially new ones, more anxious.

Such investors’ latest concern is “another probable catastrophe” brought on by issues with the European banking sector. In response to concerns that European banks are under severe stress, shares of major banks like Credit Suisse, Swiss Bank, and Deutsche Bank dropped sharply. In a single day, the share prices of Credit Suisse and Deutsche Bank plunged by 10% in the European banking sector. In response to concerns that European banks are under severe stress, shares of major banks like Credit Suisse, Swiss Bank, and Deutsche Bank dropped sharply. In a single day, the share prices of Credit Suisse and Deutsche Bank plunged by 10% and 5%, respectively. Shares of Credit Suisse have decreased 60% so far this year.

According to some observers, the scenario might turn into a repeat of the Lehman crisis of 2008, which triggered a global recession. Market analysts claim that even if India is in a better state than this country, the effects would be seen everywhere. Market experts claim that even though no one can predict what may happen as a result of the European financial crisis, markets will continue to be volatile for some time. A strategic plan to avoid bankruptcy is expected to be announced by the CEO of Credit Suisse on October 27.

Credit Suisse has stumbled from one crisis to another - but the panic is possibly overdone | Business News | Sky News

According to fund managers who feel the situation is uncertain, Indian equity mutual fund investors should be ready for volatility.

We do observe some pressure on European banks as a result of their rising CDS (Credit Default Swaps) levels and the sharp decline in stock prices. It’s important to realize that this is not 2008 anymore. Back then, a credit issue was the cause of the catastrophe. One portion, which wasn’t working well and made me anxious, received too much credit. That developed into liquidity and solvency problem, “explains Arvind Chari, CIO of Quantum India, UK.

“As of right now, there is no concern with global banking credit. What we are observing suggests that there may be several trading-related problems. Because of how the exchange rates have changed, there are some trading positions and mark-to-market losses that are rather large. That is one of the banks’ justifications. India will influence the flow of emotions and might cause market volatility. However, the Indian banking industry is in a lot better position, according to Arvind Chari.

Globally, the interest rate cycle is accelerating swiftly. As it develops in the European banks, we can observe its effects on the world economy. Nobody knows for sure if it will resemble 2008. Unquestionably, it is not now that way, but it might change.

According to Tata Mutual Fund Senior Fund Manager Sonam Udasi, the goal of central banks throughout the world is to reduce inflation. Typically, central banks have stepped in to support after 2008, but we’ll have to wait and watch how that plays out in this situation. The pressure would increase if more banks of this type released problems of this type.

Even while things appear to be much better in India, the effects of a globalized economy will still be felt. So, in the immediate term, we anticipate further market volatility, says Sonam Udasi, Senior Fund Manager, Tata Mutual Fund.

The equities markets are anticipated to see moments of volatility during the next two months, according to both fund managers. They predict that there will be a considerable impact on investment portfolios. If you are an investor with a time horizon of five years or more, try to ignore the volatility in this period. After the crisis is over, many investors find it difficult to reenter the market. Stay devoted, Sonam Udasi offers advice.It's a little bit of history repeating in Credit Suisse's litany of losses

The situation is serious and might worsen into a major disaster. But history demonstrates that predicting the market is difficult. The current COVID-fueled crisis was expected to culminate in a bear market phase for the stock market. But the market defied pessimistic predictions. In reality, following a crisis, the market always bounces back. It’s never easy to anticipate when a market will take off and to enter the industry at the right time. As a result, the majority of financial advisors urge clients to stick to their investment plans during challenging circumstances.

edited and proofread by nikita sharma 

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