Home / Opinion / Views /  How accurate is the online speculation on Credit Suisse?

There is information and there is disinformation. While the latter might not immediately be recognized as such, hindsight makes clear its identity, and could result in penalties for those who produce and spread it around. But there is yet another category of information which could be as damaging as misinformation but would, in most cases, stay clear of culpability: speculative information.

Speculative information is playing havoc with venerable Credit Suisse, in operation since 1856 and one of the world’s systemically important banks. Its share price has been tanking for more than a year, and with good reason, till July this year, when the Bank announced a change of guard, an end to the scandals that had been plaguing the bank, and a restructuring, whose details are to be announced on October 27. The stock price had fallen from over Swiss francs 14 early last year to about Swiss francs 5 in July. Thereafter, it had held steady till September 21, after which it started to tumble, dropping below Swiss francs 4, and has continued to fall after the restructuring announcement. From over Swiss francs 14 per share early last year, towards end September, speculation has run rife on social media that the bank is in serious trouble.

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Aiding this line of speculation has been the cost of insuring against default by the bank on its debt. Credit default swap (CDS) prices for Credit Suisse have risen of late, indicating a perception of increased risk.

A credit default swap is a derivative that hedges against the risk of default on a bond by the issuer. Think of it as a tradeable insurance premium that swaps the risk of default to the insurer. Along with derivatives to hedge against currency risk and interest rate risk, credit default swaps enable a bond market to function efficiently.

The level of risk indicated by credit default swaps has traditionally rarely materialised as actual default, suggesting that credit default swaps are more useful for indicating the direction of change in risk than in yielding a precise measurement of the risk of default. The fact remains that the bank is well capitalized.

Banks are required to hold capital that can be used to absorb losses, if these materialize. After the global financial crisis of 2008, the Basle, Switzerland-based Bank for International Settlements (BIS) has stipulated stringent norms for how much capital banks should hold in relation to their assets (a loan is an asset, as are investments in bonds). Since all assets do not have the same risk profile — a government bond has negligible risk, a loan to a diamond merchant with business in a foreign country would have high risk — the value of assets is arrived at as the weighted sum of assets, each asset being weighted with the risk associated with the asset class it belongs to. How to value derivative instruments is not quite black and white, either.

Bank capital itself has essentially two tiers. Tier 1 comprises the common equity tier (CET) and the Additional Tier 1. Tier 2 has revaluation reserves (a building owned by the bank could appreciate over the years), funds set aside to cover against bad loans and subordinated debt. Tier 2 capital cannot be more than 25% of a bank’s capital.

CET is the most dependable capital. Additional Tier 1 consists of bonds issued for the purpose of absorbing loss just as equity does: AT1 bonds typically offer returns higher than on bonds of a similar tenor and creditworthiness of the issuer, because of the risk of abating, in case of a loss-absorbing contingency.

BIS demands big banks that are considered to be globally systemically important to hold higher levels of capital than what smaller banks are required to hold. Each regulatory jurisdiction can stipulate its own capital adequacy norms, so long as these do not fall below Basel III norms.

Credit Suisse meets Basel III norms of capital adequacy, with ratios well above both the BIS minimum and the higher standard set by Swiss regulators.

The problem with trying to augment capital buffers when the share price is sliding is that issuance of fresh equity becomes a very expensive option. That means asset sales, staff pruning and the like to generate funds.

A spate of scandals had hit Credit Suisse in the recent past. The one that led to purging of the top management was spying on senior staff. While the then CEO was not directly held responsible, he had to carry the can for allowing it to happen on his watch. Before that there was a money-laundering operation run through the bank by Bulgarian drug gangs. In October 2021, the bank was fined some $475 million for a Mozambique tuna bonds scam, in which some bank officials turned a blind eye to a bond issuance, supposedly for buying fishing boats, on claimed fish catches several times as large as Mozambique’s actual levels, being used to buy marine defence vessels. Credit Suisse lost serious money in the Archegos Capital scandal, in which the bank financed high-risk derivatives trade by a private office, and in the Greensill Capital debacle, in which a supply chain financing company that created unsustainable levels of debt collapsed under that debt burden. The proclivity of Credit Suisse bankers to venture into such risky lending told a tale of poor risk culture and lax supervision within the bank.

The current CEO and Co-CEO took over in July this year and announced a restructuring that would both improve the capital structure, get rid of some divisions and trim investment banking. The details were to be announced later this month.

A series of high-profile departures have taken place since then, rival banks luring away reputed Credit Suisse category heads. It is not surprising that skilled personnel prefer the certainty of higher pay in new pastures to the uncertainty of job continuity in a restructuring still months away. These departures did not enhance the bank’s reputation on the stock market.

But what happened to the bank’s credit default swaps and share price in the last week of September has no clear explanation. Social media commentary could sway the retail investor, but institutional investors should be immune to uninformed chatter.

CEO Ulrich Koerner has thus been constrained to issue reassuring statements to employees (and other stakeholders) about the bank’s financial health and brighter future after restructuring, the blueprint for which is to be announced on October 27.

The battle between information vouchsafed by the CEO and online speculation continues, with the share price taking a toll.

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