We finally have the total cost of the Archegos disaster for Credit Suisse: 4.4bn CHF.

There is one question I get A LOT: how is it possible that Credit Suisse took a multi-billion exposure on a “family office”?

I will try to explain - A thread. https://twitter.com/FT/status/1379190333376970760

First it should be stressed how extraordinary that exposure is.

One of the most important rules in banking (the one which puts Greensill in a *lot* of trouble) is called the large risk limit.

It says max exposure should be 25% of own funds.

In practice, most banks set internal limits around 10% - that would be approx. 5bn CHF.

How on earth did Credit Suisse get to a 4bn+ exposure?

The reason is probably that they didn't even know & I will try to explain why as simply as possible.

There are three main risks in banking: credit, market and operational.

Operational risk is fraud, fines, disasters, etc.

Market risk is when you’re directly exposed to the change of price of tradeable assets.

Lending to a leveraged fund is none of those: it’s credit risk.

It might be counterintuitive but I have to stress this: lending to Archegos is *not* market risk, because CS is not directly exposed to changes in the prices of shares, that risk is fully hedged.

The risk is really a credit risk on the fund.

Credit risk has to two big components: “general” credit risk and counterparty credit risk (CCR).

The former is any loan, lease, etc., whatever transaction that exposes you to credit risk and that you hold in your balance sheet.

The second is what we are interested about here: it is the risk that a counterparty defaults on a financial instrument (usually a derivative) creating a P&L impact.

The HUGE difference between the two types of credit risk is the notion of exposure.

In the general credit risk framework, exposure is (almost) straightforward: it’s the amount of the loan, lease, etc., that the borrowers owe you.