Why is Credit Suisse in trouble? The banking turmoil explained

Stress in the US banking system crossed the Atlantic this week, sending turmoil to Swiss bank Credit Suisse..

CS -6.94%

The European lender has been dogged by problems. But on Wednesday, the problems around the bank exploded in plain sight. After a 24-hour whirlwind marked by a dramatic drop in the bank’s share price and concerns of financial contagion, Credit Suisse said it would borrow money from the Swiss central bank to bolster its liquidity. On Saturday, Credit Suisse’s biggest rival UBS Group AG

UBS -5.50%

was in negotiations 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?

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

The bank’s core business is managing money and creating investment products for wealthy clients around the world. Recently, Credit Suisse has been working to spin off its investment banking arm as part of an attempt to overcome a long string of scandals and quarterly losses.

What caused the crisis at Credit Suisse?

Investors are on high alert for signs of contagion after the rapid collapse of California-based Silicon Valley Bank last week. This led to a liquidation of shares in banks around the world, including Credit Suisse.

But the Swiss lender’s problems became particularly acute on Wednesday when its biggest shareholder, Saudi National Bank, said in an interview with Bloomberg TV that it was not considering increasing its investments due to regulatory rules. The Saudi National Bank owns 9.9% of Credit Suisse. Capital requirements generally prevent banks from owning more than 10% of other banks.

How did investors react to the Saudi National Bank statement?

The timing couldn’t be worse. Investors were already nervous about other potential weak links in the financial system. The comments heightened his concerns about the bank’s ability to make money and raised the prospect that it might again have to turn to shareholders for funds.

So-called credit default swaps soared as investors rushed to hedge against a possible Credit Suisse default. At the same time, shares in the Swiss lender plummeted, losing 24% on Wednesday – their biggest one-day drop in history. Their bond prices have fallen to troubled levels.

Traders rushed to buy Credit Suisse-linked options as activity reached its highest levels in recent history, according to data provider Trade Alert. Puts — or bearish contracts that typically profit when a stock falls — outperformed bullish calls.

Credit Suisse’s customers and regulators were watching closely. European Central Bank officials called the banks it supervises to ask about their exposure to Credit Suisse, people familiar with the matter said. Meanwhile, some customers stopped dealing with the bank, The Wall Street Journal reported.

What happened after the market panic?

After European markets closed on Wednesday, Swiss regulators said they would provide Credit Suisse with liquidity if needed.

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

This drove up the price of Credit Suisse shares. Thursday, lifting other European banks alongside it.

Credit Suisse may not need the cash, analysts said. Instead, it lent the money to reassure investors of its ability to come up with cash quickly.

Dan Davies, head of research at Frontline Analysts, said the bank was unlikely to use the facility to cover operating costs. He used the bailout to buy liquid bonds, which could be sold quickly if the bank needed the cash, improving its balance sheet, he said.

“They achieved this primarily with the aim of waving and saying to everyone, ‘Look at our strong liquidity ratio,’” he said.

It was likely a show of strength for investors who shorted Credit Suisse shares or sold credit default swaps as collateral against default, said Jérôme Legras, head of research at Axiom Alternative Investments.

Are some investors still worried about Credit Suisse?

Yes. The beleaguered creditor’s bonds and other securities continue to show signs of stress.

Credit Suisse shares were down nearly 7% in Switzerland on Friday, meaning the stock has lost about a fifth of its value this week. Meanwhile, prices for Credit Suisse bailouts, which are wiped out if the bank gets into serious trouble, saw little recovery.

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

How far do Credit Suisse’s problems go?

For years.

The bank went through a period of market crises, executive turnover and financial losses. Most notably, it was burned by its connection to the separate collapses of the now bankrupt Greensill Capital and Bill Hwang’s Archegos Capital Management. In 2021, Credit Suisse took a $5 billion hit due to the collapse of Archegos, which was equivalent to over a year of profit.

More recently, the bank has struggled with customer withdrawals. In October, a social media firestorm about the bank’s health led to wealthy clients leaving, Credit Suisse executives said.

Withdrawals continued through the end of the quarter and prompted the bank to personally contact more than 10,000 wealthy customers to reassure them of the bank’s health.

Deposits fell 40% last year to 234 billion Swiss francs, equivalent to $252 billion, while total assets fell 30% to 531 billion francs, or about $571 billion, because the bank was, among other things, reducing their business. Credit Suisse reported a net loss of 7.3 billion francs in 2022, after posting a net loss of 1.7 billion francs the year before.

Investors were already spooked by last year’s outflows. “Their investors and deposit holders have basically been nervous about this,” said Octavio Marenzi, chief executive of consultancy Opimas.

Wealth management clients are extremely conservative investors with large amounts of cash and were concerned, he said. “It’s been a slow-motion unfolding with CS that reached a breaking point and a tipping point a few days ago.”

What is the difference between Credit Suisse and Silicon Valley Bank?

Credit Suisse primarily manages money for people with millions of dollars to invest. The bank counts billionaires and sovereign wealth funds among its biggest clients. Most of its loan portfolio is in ultra-conservative Switzerland, where it is the country’s second-largest bank by assets, catering to savers and businesses. It also has large investment banking and asset management arms.

It is considered a systemically important bank by global regulators due to its size and interconnection with the financial system.

Silicon Valley Bank was a regional bank, catering to US venture capitalists and tech startups.

Credit Suisse, as is typical in the industry, made 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 happens now?

Swiss authorities are eager to stop Credit Suisse’s demise by striking some sort of deal with UBS — and soon. UBS’s balance sheet is twice as large as Credit Suisse’s, and it has proven to be a much stronger and more stable bank.

A transaction is not simple, however. Silicon Valley Bank’s parent company had a few other businesses, but the bulk of it was a domestic bank that did the bank’s direct work—taking deposits and making loans.

Credit Suisse is much more complicated. It has a domestic (Swiss) bank, a global operation managing money for wealthy clients, and an investment bank. UBS may keep some or all of these parts, or other bidders may come forward for parts – or a transaction may not go through.

What implications do Credit Suisse’s problems have on the global banking system?

Credit Suisse is deeply integrated into the global financial system, working closely with a number of banks and institutional investors. European bank shares fell last week due in part to investors’ fears of contagion, investors said.

On a broader level, the problems at Silicon Valley Bank and Credit Suisse led investors to believe that the Federal Reserve might halt or reduce its plans to further raise interest rates to control inflation.

This explanatory article may be updated from time to time.

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

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