An RBI lesson for Europe

Context:

• Banking stocks and bonds plummeted as the hit to investors from UBS Group’s state-backed takeover of Credit Suisse fanned concerns about the health of the global banking sector.

Factors for decline:

• Paying the risky bets: bank (that is, their management) is paying the price of either undertaking risky bets or ignoring prudential norms. For example Credit Suisse lost big chunks of money by investing in firms that soon went bankrupt.
• Macro policy: The global economy has had a very long period of loose monetary policy followed by a sudden and very sharp monetary tightening. This led to sudden spike in risky credit lending which bank could not adjust.
• Leadership: In 2020, Tidjane Thiam, the then CEO of Credit Suisse, stepped down from the troubled Swiss bank, giving in to pressure from select quarters.

Impact:

• Eroding confidence: The wipe-out of the entire portfolio of contingent convertible/AT1 bonds worth $17 billion will erode confidence for new issuers, and raise the risk premia disproportionately in this $250 billion bond market.
• Changing ratings: The CDS (credit default swap) of Credit Suisse, already approaching alarming high levels in recent days for protection against near-term default, may result in rating changes for financial markets and even sovereigns. 
• Spread of Contagion: The collapse of these banks has eroded that trust. People and policymakers alike are worried about the spread of this contagion.