No, Credit Suisse is not on the brink
The terms of trade on the financial markets are deteriorating for all players. It’s a new era of heightened volatility as policymakers raise interest rates to fight inflation, increasing business costs and risks. This is a time when the missteps of politicians or central banks can suddenly reveal surprising concentrations of risk – just look at last week’s tangle between the UK government bond market and UK pension funds .
Unfortunately for Credit Suisse, this will encourage companies, investors and savers to do more business with the banks with the strongest balance sheets and the most stable business models, making speed crucial for Chairman Axel. Lehmann to complete the bank’s strategic review and launch its restructuring. . On the one hand, the Swiss lender is simply suffering from a more exaggerated version of the difficulties of its peers. But the collapse of its share price and the sharp rise in the cost of insuring its bonds make its recovery more difficult. And there are still three weeks to go before he is due to tell investors how he will cut back his investment bank to focus more on wealth management.
The bank has more than enough capital to run its business. It just doesn’t make enough good returns. To quickly change that picture, it needs cash to pay for a restructuring — analysts estimate potentially $4 billion through asset sales or capital raising. Without it, the less he can change, the longer his problems will last. The weaker it appears, the more expensive it will be to raise funds and the harder it will be to be pressured by potential buyers of one of its assets. Markets thrive on desperation, and you’ll find fewer friends when you need them most.
But it’s a story of relative decline, not bank runs or existential crisis. This is well known to investors and analysts who follow Credit Suisse, but not so much to the broader market. That’s why the steep rise in the cost of protecting Credit Suisse bonds from default in the derivatives markets has spooked some financial professionals as well as social media.
Credit Suisse senior executives spent time reassuring clients and counterparties over the weekend about the health of its balance sheet, the Financial Times reported. In the United States, some investors began to worry about the contagion to the banking system of the problems of a major European bank. Citigroup Inc. banking analyst Keith Horowitz was tricked into writing a note to clients reassuring them that “the current situation has been night and day since 2007.”
Investors and traders are nervous because the cost of protecting bank debt from default using credit default swaps (CDS) is rising everywhere. Some are beginning to see a harbinger of bank failures, but that’s not true. Much of this increase is a function of how banks manage transaction risk between themselves – and how their customers manage that risk as well.
When banks negotiate with each other, there is always a risk that a bank will not fulfill its end of the bargain – this is called counterparty credit risk. The world of over-the-counter derivatives, those that are not traded on an exchange or through a clearing house, is a significant source of counterparty risk. The amount involved depends on the size of your trading portfolio, but also on the volatility of the underlying market. High volatility often means more and more frequent collateral calls, as the UK pensions sector showed last week.
Banks (and their customers) also need to look at the financial strength of their business partners when determining how risky they are: Credit Suisse’s crashing stock price makes it look riskier than some rivals. This is a real problem because it makes the bank a more expensive and less competitive counterpart. Deutsche Bank experienced a similar situation towards the last months of 2016, when its capital base was weak and it faced a potentially existential fine from US authorities. Credit Suisse is not in as dire a position as Deutsche Bank was then, but the loss of revenue will still be painful.
There is another nuance to note that explains why the headlines about Credit Suisse are worse than the reality. Without going into too much technical detail, many European banks have two types of CDS that refer to senior debt: one is riskier and less traded than the other. These exist because different creditors receive different treatment under bank resolution rules: depositors and derivative counterparties are generally more likely to get their money back if a bank is liquidated than bondholders.
In short, and a bit simplistic: there is a CDS for senior bonds and a less risky CDS for counterparty credit risk. The first version is often more volatile, the second is more important for competitiveness and revenues. For Credit Suisse, it’s the most volatile and risky version that has gone wildest in recent days and has become a popular chart for Twitter’s excitable storm chasers.
Credit Suisse is still considered a riskier counterpart than Deutsche Bank or Barclays Plc, for example, but it is not in existential jeopardy today. It is at a commercial disadvantage and faces another obstacle to its restructuring. Nothing that has happened in the markets or been communicated by the bank since it launched its review this summer has been helpful. Financial markets are not becoming more user-friendly. The sooner Credit Suisse’s board can complete its strategic plan and put an end to the uncertainty, the better.
More from Bloomberg Opinion:
• Credit Suisse could turn to the Buffett solution: Paul J. Davies
• October fears start with Credit Suisse and inflation: John Authers
• Credit Suisse and the Hotel California effect: Marc Rubinstein
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.
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