A Lehman Moment for European Banks? The Market Says No.
Rising credit risk among multiple European banks may concern investors, as it brings back memories of the 2008 global financial crisis. Capital buffers have significantly increased, however,1 and spreads of credit-default swaps (CDS) — although high in a historical context — do not point to imminent sector-wide defaults as of now, based on our modeling.2 Amid the general widening in European banks’ credit spreads, Credit Suisse and Deutsche Bank have seen the largest surge in their CDS spreads and sharp drops in their equity prices. Market attention has been increasingly focused on the banks’ potential for default — and what that could mean for markets.
Credit-spread curves have steepened
Credit spreads for Credit Suisse and Deutsche Bank are now at historically wide levels,3 and other European banks’ spreads have also widened significantly. But the slope of the credit-spread curves has generally steepened instead of inverting (as the exhibit below shows). Inversion of the curve would reflect investors’ short-term default concerns, and this was observed in 2008 across banks. Credit Suisse is the only major bank for which the curve has recently flattened.
A standard model using current CDS pricing shows a market-implied six-month default probability of approximately 2% and 1% for Credit Suisse and Deutsche Bank, respectively, and a five-year default probability of 23% for Credit Suisse and 17% for Deutsche Bank. While elevated, these market-implied probabilities do not suggest imminent default over the short term, though over the longer term market concern about the viability of both firms is more apparent.
All that to say, the market data suggests that a Lehman moment for European banks does not seem likely for the time being.
Majority of European G-SIBs’ credit spreads have steepened
Comparing CDS-implied default probabilities to those during the global financial crisis
1 Basel III Monitoring Report.” Basel Committee on Banking Supervision, September 2022.
2 We used a standard model to derive market-implied default probabilities based on issuer CDS spread curves, assuming a 40% recovery rate. Note that not only default, but also a debt restructuring could trigger a CDS contract.022.
3 These banks reached the highest CDS spread levels of those European banks in our analysis.
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