Where was the risk management at Credit Suisse? Are banks exposed to additional risk from their big clients?
Banking by definition involves risk. If you lend money to people and companies, some of them won’t be able to pay it back. The difference between a good bank and a bad one lies in how it manages that risk. Bankers who are too cautious starve the economy of funds needed to fuel trading and growth and they don’t make profits. Those who throw money at the wrong people at the wrong time can end up in big trouble. FT.com 31/03/2021.
The increase in risk that banks are currently running could be blamed on poor risk management or it could be because they need to keep profitability ticking over in the current low interest rate environment. As well as offering riskier loans due to the higher margin available, banks have been exposing themselves to other risks with the leverage now being offered by banks to some investment businesses.
In early March, Credit Suisse, Switzerland’s second-largest bank became badly entangled in the collapse of the finance group Greensill Capital and now it appears to be one of the biggest losers from the spectacular blow up of Archegos Capital Management.
Credit Suisse shares have plummeted since it disclosed that its losses from Archegos could be “highly significant.”
On March 29, Archegos, a $10 billion single-family office run by former Tiger Asia manager Bill Hwang, defaulted on margin calls by its banks. A fire sale of stocks by the banks caused big drops in the share prices of those linked to Archegos. The question has to be asked, ‘how did Archegos, who had assets of around $10 billion, be allowed to build up huge, non-public positions in a small number of stocks worth more than $50 billion?’.
Prior to the Archegos blow up Credit Suisse had just warned of expected losses due to its exposure to Greensill Capital and Greensill Bank.
What happened at Greensill Capital and Greensill Bank?
With Greensill, the issue was supply-chain finance sometimes called “reverse factoring”, because it is a new spin on a centuries-old technique of raising money from invoices. In practical terms, the process involves a financial institution agreeing to pay the bills a company owes to its suppliers.
Greensill arranged funding for companies either through its own German based bank, Greensill Bank, or by packaging these supplier bills up into bond-like investments for the Credit Suisse funds. It made money from being the middleman between companies and investors. Greensill also does traditional factoring — in which a company sells on its customer invoices at a discount. Greensill did not invent supply-chain finance — banks in the US and Europe have provided this type of financing to clients for decades. However, the firm has been at the cutting edge of creating even more complicated structures for certain companies.
There now appear to be over 1000 holders of the $10 billion plus of defaulted Greensill investment structures packaged and issued by Credit Suisse who stand to only recovery 30% of their capital from what they thought were ‘ultra-safe secured investments’.
Who failed to spot the problem?
The German regulator certainly failed to see what was going on at Greensill’s Bank and the risk team at Credit Suisse certainly appears to have struggled to keep on top of big clients.
Are there more issues as yet uncovered?
Large investment banks provide prime brokerage services to hedge funds, which is a capital intensive business and potentially risky. There is little doubt that excessive leverage and risk-taking after years of strong asset markets is rife. Banks that offer large credit facilities to investment firms or deal in complex European securitisation/receivables are very exposed to market shocks.
It appears that while net interest margins are at historically low levels, certain banks will take on more risk to compensate. When we see a tightening in financial conditions banks should becoming more cautious, which from a depositor risk perspective will be good. Until then any market downturns may expose more unforseen bank losses.