Will `Credit Suisse` Trigger Another Global Financial Crisis?

Will `Credit Suisse` Trigger Another Global Financial Crisis?

October 13, 2022 - 5:49 am

The World Should Prepare For Another Lehman-Like Financial Collapse

Growing worries about Credit Suisse, the second-largest banking in Switzerland, have raised questions about whether the world should prepare for another Lehman-like financial collapse. In the 2008 financial crisis, its larger Swiss competitor UBS Group had obtained a government bailout. Its major bank, Credit Suisse, has suffered a string of severe blows. Over the past year, the stock price of the bank has decreased by more than 55%. The bank's credit default swaps (CDS), which are trading at their highest level since 2009, show more signs of trouble than the stock price. The cost to insure the institution's bonds is measured by CDSs, or credit default swaps.

Reasons for Financial Crisis

Insiders acknowledge that there are two reasons for many of the significant frauds and losses in recent years. First, the sales team overtook risk due to aggressive investment banking and lopsided incentive systems. Second, Credit Suisse made mistakes by allowing the sales and business development team to override the risk and compliance staff.

1)  The first big crisis for Credit Suisse manifested when Greensill went bankrupt in March 2021. Credit Suisse had an exposure of $10 billion. A supply chain finance company called Greensill packaged supply chain receivables into bonds and offered them as safe investments to rich customers. Although it would depend on insurance claims and realisable value, it has only been able to recoup a portion of the money and could end up losing money.

2)  There was no such confusion on the quantum of losses in Bill Hwang’s Archegos Capital. Bill Hwang's family office received significant funding from Credit Suisse. In the end, the Archegos transaction cost Credit Suisse $5.5 billion in losses. If Archegos had sold its shares in companies like Goldman Sachs and Morgan Stanley, its losses would have been significantly lower.

3)  The third problem involved slush money. Criminal money laundering accusations are being brought against Credit Suisse for handling payments for a cocaine trafficker. In connection with the fraudulent Mozambique tuna bonds, which were loans created for the Republic of Mozambique, Credit Suisse was fined £350 million. Credit Suisse has funded high risk assets like private aircraft and superyachts for Russian oligarchs that are in trouble amidst the Ukraine war.

Credit Suisse's situation could have been much worse because it was the second-largest financier for China's Evergrande. Fortunately, it took the advice of Archegos and left just in time.

Report of Credit Sussie

According to Credit Suisse, it plans to expand its wealth management business, transform its investment bank into a "capital-light, advisory-led" operation, and assess strategic options for its Securitized Products division. According to analysts, it may need to raise between 4-6 billion Swiss francs in capital to restructure, sustain growth, and have a safety net, depending on how much it generates via asset sales and how much it reduces the size of its investment bank. Asset sales will help, but it's more likely that the 4 billion Swiss francs will come via a heavily diluted capital offering. The good news is that part of this is reflected in the share price already. As a last resort, a directed capital increase towards a significant shareholder can be a possibility.

Context of Credit Suisse Report

Even in the worst-case scenario, any fallout from a possible Credit Suisse explosion would only have a temporary effect on India's financial markets, while a spread to Indian banking systems seemed doubtful. Just Rs 20,732 crore were on the Indian branch of Credit Suisse's balance sheet at the end of FY22. Investors, however, will be keenly monitoring any action taken by the Swiss government as well as the viability of Credit Suisse's soon-to-be-released restructuring plan.

Domino Effect of Banking Sector

We have observed over time that the banking industry does not function in a vacuum. The sector is now one continuous mass as a result of cross-holding and lending to one another. Although it would appear like Credit Suisse is a unique incident, when a major bank fails, it often brings other institutions with it. Money will leave equities markets as a result of a capital flight to safer havens as a result of the problem. The time is still there for Credit Suisse to clean up its act. The system has sufficient liquidity, and the bank has enough assets to save itself and avert another financial crisis. That is the very last thing the world needs right now. Given that Credit Suisse is a member of the global TBTF (too big to fail) banks, the cost of allowing it to fail is too high. A Credit Suisse failure would have a massive domino effect that would affect all markets. The answer may be to capitalize Credit Suisse and let the show go on. A lot will ultimately depend on the plan announced on October 27th for that.