Asian stocks shaky as banks see cost of default insurance rises

Asian stocks struggled at the beginning of the trading week as the global banking system tried to cope with the rising cost of insuring against default.

MSCI's broadest index of Asia-Pacific shares excluding Japan fell by 0.7 percent on Monday local time, largely due to a 0.5 percent decline in China's blue-chip CSI 300 index. Japan's Nikkei 225 gained 0.31 percent on mid-day, but South Korean Kospi saw a 0.033 percent loss. The Hang Seng index in Hong Kong also plummeted 0.51 percent to 19,815.03.

Global stock markets remained volatile after Germany's Deutsche Bank closed 8.5 percent lower on Friday. The multinational investment bank reported that its credit default swaps (CDS) — the cost of bond insurance against the risk of default — soared to the highest level in several years. Several other European banks also reported a surge in CDS.

"The current level of credit default swaps for European banks is just a little lower than it was during the height of the European financial crisis in 2013."

Naeem Aslam, Chief Investment Officer at Zaye Capital Markets

According to Zaye Capital Markets chief investment officer Naeem Aslam, the current level of CDS for European banks is just under the CDS level during the peak of the European financial crisis in 2013.

"If these CDS do not normalize, it is highly likely the stock market may continue to suffer for many days," Aslam added.

German Chancellor Olaf Scholz has assured the public that Deutsche remains a "profitable bank." Scholz also said there was no basis to speculate about the bank's future.

Along with Deutsche, other European banks also closed lower on Friday. Deutsche's local rival Commerzbank lost nine percent of its stock value. Meanwhile, France's Societe Generale and Switzerland's UBS fell by around seven percent each. British bank Barclays also traded six percent lower on the same day.

The development of Deutsche followed the recent buyout of Switzerland's Credit Suisse by domestic rival UBS. The Swiss National Bank (SNB) facilitated the buyout after Credit Suisse experienced a liquidity crisis and the central bank's $54 billion lifeline was unable to save the lender.

Swiss financial authorities insisted that the buyout would stabilize the banking system in the country, but analysts said it did little to convince the public about the soundness of the sector.

Six central banks, including the SNB and U.S. Federal Reserve, have expanded their dollar swap program to enhance dollar circulation in the market. The daily swap, which originally ran weekly, enables participating banks to provide dollar liquidity to domestic banks to prevent similar liquidity issues as Credit Suisse.

New York-based credit rating agency Moody's said in a note last week that actions taken by financial regulators in recent weeks should be able to prevent spillover effects from troubled lenders.

However, Moody's pointed out that an uncertain macroeconomic environment and "fragile" investor confidence increased the risk of longer-lasting effects of the recent banking crisis on the economy. Moody's strategists added that it could impact other sectors too.

"Even before bank stress became evident, we had expected global credit conditions to continue to weaken in 2023 as a result of significantly higher interest rates and lower growth, including recessions in some countries," Moody's wrote in the note.

Banking stress in U.S.

The effect of the recent banking stress was still prevalent in the U.S., as reports suggested that depositors had pulled out their money from smaller lenders. They either deposited the money in larger banks or invested in money market funds. Data showed that the inflows of money market funds had risen by over $300 billion in the past month, reaching a record of $5.1 trillion.

Minneapolis Fed President Neel Kashkari said officials were watching the development in the banking sector "very, very closely" in case the recent stress led to a credit crunch that could push the economy into a recession.

Kashkari added that it means the central bank was close to reaching a terminal federal funds rate for the current tightening cycle. Last week, the Fed hiked the benchmark rate by 25 basis points to the range of 4.75 to 5.00 percent.