Why is Credit Suisse in trouble? The banking crisis explained

Stress in the US banking system jumped across the Atlantic this week, sparking turmoil at struggling Swiss bank Credit Suisse.

CS -6.94%

The European lender has long been plagued by problems. But on Wednesday, the problems surrounding the bank exploded in full force. After a 24-hour whirlwind marked by a dramatic drop in the bank’s share price and concerns over financial contagion, Credit Suisse said it would borrow cash from Switzerland’s central bank to shore up its liquidity. On Saturday, Credit Suisse’s bigger competitor, the UBS Group Inc

UBS -5.50%

He was in talks to take over all or part of the bank.

Here’s what you need to know about how Credit Suisse got here and what might happen next.

First things first: What is Credit Suisse?

The history of Zurich-based Credit Suisse dates back to 1856, when it was founded to finance the expansion of the Swiss railways. Today it is the second largest bank in Switzerland by assets, behind UBS.

The bank’s core business is managing funds and developing investment products for wealthy clients around the world. Recently, Credit Suisse has been working to spin off its investment banking arm, putting a long string of scandals and quarterly losses behind it.

What triggered the crisis at Credit Suisse?

After the rapid collapse of California’s Silicon Valley bank last week, investors were on high alert for signs of contagion. This prompted a sell-off in stocks from banks around the world, including Credit Suisse.

But troubles for the Swiss lender became particularly acute on Wednesday when its largest shareholder, the Saudi National Bank, said in a Bloomberg TV interview that it was not considering increasing its investment due to regulatory concerns. The National Bank of Saudi Arabia owns 9.9% of Credit Suisse. Capital requirements often prevent banks from owning more than 10% in other banks.

How did investors react to Saudi National Bank’s statement?

The timing couldn’t have been worse. Investors were already nervous about other potential vulnerabilities in the financial system. The comments increased her concerns about the bank’s ability to make money and raised the prospect that it might have to tap shareholders for funds again.

So-called credit default swaps rose sharply as investors rushed to hedge against a possible default by Credit Suisse. At the same time, shares of the Swiss lender plummeted, shedding 24% on Wednesday – the biggest one-day loss on record. Its bond prices fell to worrying levels.

Traders rushed to snap up options tied to Credit Suisse, with activity hitting the highest level in recent history, according to data provider Trade Alert. Put options — or bearish contracts that typically profit when a stock falls — outperformed bullish call options.

Credit Suisse clients and regulators were watching developments closely. European Central Bank officials called the banks it oversees to inquire about its exposure to Credit Suisse, people familiar with the matter said. Meanwhile, some customers paused trading with the bank, the Wall Street Journal reported.

What happened after the market panic?

After European markets shut down on Wednesday, Swiss regulators said they would provide liquidity to Credit Suisse if needed.

Within hours, Credit Suisse said it would tap a more than $50 billion lifeline from the Swiss National Bank.

This caused the Credit Suisse share price to continue to rise Thursday, other European banks raise alongside.

Credit Suisse may not even need the money, analysts said. Rather, it borrowed the money to convince investors that they were able to get cash quickly.

Dan Davies, head of research at Frontline Analysts, said the bank is unlikely to use the facility to cover operating costs. It used the aid to buy liquid securities that could be sold quickly if the bank ever needed the money, improving its balance sheet, he said.

“They do this primarily to have it, to wave it around and tell everyone, ‘Look at our strong cash ratio,'” he said.

It was likely intended as a show of force against investors shorting Credit Suisse stock or selling credit default swaps to insure against default, said Jérôme Legras, research director at Axiom Alternative Investments.

Are some investors still worried about Credit Suisse?

Yes. The troubled lender’s bonds and other securities continue to show signs of stress.

Credit Suisse shares fell nearly 7% in Switzerland on Friday, meaning the stock is down about a fifth of its value this week. Meanwhile, prices for Credit Suisse bail-in bonds, which will be destroyed if the bank runs into serious trouble, have barely recovered.

Investors continue to buy protection against the bank defaulting on some of its debt. The cost of insuring against default on Credit Suisse five-year senior debt is double what it was at the start of the week.

How far back do Credit Suisse’s problems go?

for years.

The bank weathered a period of market crises, executive turnover and financial losses. Most notably, it was burned by its connection to Bill Hwang’s separate failures of Greensill Capital and Archegos Capital Management. In 2021, Credit Suisse suffered $5 billion in damage due to the collapse of Archegos, equal to more than a year’s profit.

More recently, the bank has struggled with customer withdrawals. In October, a social media firestorm over the bank’s health led to outflows from wealthy customers, Credit Suisse executives said.

The withdrawals continued through the end of the quarter, prompting the bank to personally approach more than 10,000 wealthy customers to reassure them of the bank’s health.

Deposits fell 40% last year to 234 billion francs, or $252 billion, while total assets fell 30% to 531 billion francs, or about $571 billion, partly because the bank scaled back its operations. Credit Suisse reported a net loss of CHF 7.3 billion for 2022 after reporting a net loss of CHF 1.7 billion the previous year.

Investors were already spooked by last year’s outflows. “Their investors and their depositors basically looked at this with some trepidation,” said Octavio Marenzi, chief executive of consultancy Opimas.

Wealth management clients are extremely conservative investors with very large amounts of money and are concerned, he said. “It was a slow motion unfolding with CS that reached a breaking point and tipping point a few days ago.”

How is Credit Suisse different from Silicon Valley Bank?

Credit Suisse mainly manages funds for people with investments in the millions. The bank counts billionaires and sovereign wealth funds among its largest customers. Most of its loan portfolio is in ultra-conservative Switzerland, where it’s the country’s second-largest bank by assets, serving savers and businesses. It also has large investment banking and wealth management branches.

Due to its size and interconnectedness with the financial system, it is considered a systemically important bank by global regulators.

Silicon Valley Bank was a regional bank serving US venture capitalists and technology startups.

Credit Suisse has been making industry bets to hedge against rising interest rates; Silicon Valley Bank reported virtually no interest rate hedges on its huge bond portfolio at the end of 2022.

What’s happening now?

Swiss authorities are eager to stop the Credit Suisse crash by striking some sort of deal with UBS – and soon. UBS’s balance sheet is twice that of Credit Suisse and it has proven to be a far stronger and more stable bank.

However, a transaction is not easy. Silicon Valley Bank’s parent company had a few other businesses, but the largest stake was a domestic bank that did the basic work of banking—taking deposits and making loans.

Credit Suisse is far more complicated. It has a domestic (Swiss) bank, a global operation that manages wealthy clients’ money, and an investment bank. UBS could take on some or all of those parts, or other bidders could show up for parts — or a transaction might not go through at all.

How are Credit Suisse’s problems affecting the global banking system?

Credit Suisse is deeply integrated into the global financial system and works closely with a range of banks and institutional investors. European bank stocks fell last week in part on contagion fears, investors said.

More broadly, problems at Silicon Valley Bank and Credit Suisse have led investors to believe that the Federal Reserve may delay or scale back plans to raise interest rates again to curb inflation.

This explanatory article may be updated periodically.

Write to Caitlin McCabe at caitlin.mccabe@wsj.com and Josh Mitchell at joshua.mitchell@wsj.com

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