What led to the Credit Suisse crisis, and what is the road ahead?

What has triggered the concern around Credit Suisse?

The most recent trigger seems to be a letter written by Chief Executive Ulrich Koerner to Credit Suisse’s employees on September 30.

“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,” he wrote.

Reportedly, Credit Suisse had just over 50,000 employees and 1.6 trillion Swiss francs ($1.62 trillion) in assets under management at the end of 2021.

However, it has been losing its market value since the 2008 global financial crisis (see chart). The share price has witnessed almost a secular decline. The reason for this is fairly straightforward — Credit Suisse has made several risky bets and ended up losing a lot of investor money. That, in turn, has hurt its profitability, eroded investor confidence, and has made raising fresh capital costlier.

For instance, Credit Suisse directed many customers to invest as much $10 billion in Greensill Capital. Greensill was itself a lender of sorts — it intermediated between suppliers and clients. In other words, it paid suppliers upfront cash and took their place in waiting for the clients to pay. The business attracted a lot of attention and money, thanks to banks such as Credit Suisse.

But there were increasing question marks over Greensill’s ability to remain solvent. By March 2021, Greensill had filed for bankruptcy, denting Credit Suisse and its rich investors.

When Archegos Capital Management, a hedge fund run by Bill Hwang, collapsed, also in March 2021, Credit Suisse lost another $5.5 billion.

Such losses were punctuated by high-profile managerial malpractices and exits, further undermining investor confidence. For example, in 2020, then CEO Tidjane Thiam had to quit after it became clear that he had been spying on Credit Suisse’s wealth management executive Iqbal Khan.

How did it impact Credit Suisse?

The secular decline in Credit Suisse’s share price is one good way to understand how investors have progressively shrugged away from the iconic bank.

Further, Credit Suisse bonds have increasingly become cheaper — because fewer people want to lend money to it — and this has resulted in the yields rising quite sharply. Higher yields essentially imply that the bank would have to pay higher returns for every dollar or euro it borrows from the market.

This becomes a problem, especially in the current scenario facing the developed economies, when growth prospects are tanking and central banks are raising interest rates to contain inflation.

A bank with worsening profitability has to raise money at rapidly rising interest rates, but in a market that does not provide high enough returns, it is bound to struggle.

The other equally worrisome issue is the rise in the spread of Credit Default Swaps.

What are CDS?

Essentially, a CDS is an insurance instrument. If an investor who has lent money to a firm (say Credit Suisse) is unsure about the firm’s ability to repay, the investor can buy a CDS on Credit Suisse’s bond. A CDS promises that if Credit Suisse fails to pay back, the insurer would pay the amount.

In return, the insurance firm selling the CDS gets a certain interest. This interest is called the spread of CDS. When these spreads rise, they signal the rising probability that a particular bond will fail. For Credit Suisse bonds, CDS spreads have spiked to 14-year highs.

What has Credit Suisse said?

Credit Suisse is expected to unveil a new plan to transform the bank’s functioning and gain investor confidence on October 27.

“We are in the process of reshaping Credit Suisse for a long-term, sustainable future — with significant potential for value creation. Given the deep franchise we have, with a long-standing focus on serving some of the world’s most successful entrepreneurs, I am confident we have what it takes to succeed,” Koerner wrote in the memo.