Credit Support
Credit support is the protection of a business partner against the risk that the counterparty fails to make its payments. Common forms include posted collateral such as cash or government bonds, as well as guarantees from a third party.
When two companies enter into a deal, there is always some uncertainty: will the other side actually pay later? Credit support is the umbrella term for everything that reduces this uncertainty. Most often, one side posts cash or securities that are forfeited if it fails to pay. It can also mean that a third party steps in for the debt, such as a bank or the parent company. The German term for this is simply Kreditsicherheit or Besicherung. Everyone knows the principle from everyday life: a rental deposit for an apartment is exactly this kind of collateral.
Why banks barely do business without collateral
Large financial deals run over years. During that time, a contractual partner can go bankrupt. Without protection, the other side is then left empty-handed. This happened on a massive scale in 2008, when the investment bank Lehman Brothers collapsed. Many partners had outstanding claims that no one covered anymore.
Since then, regulators have mandated collateral in many cases. For certain transactions, both sides must top up cash daily if values shift. This makes the financial system more stable, but ties up a lot of capital. Collateral sits around as a buffer and cannot be invested elsewhere.
For companies, collateralization has a second effect as well. Whoever offers good collateral gets better terms. The counterparty’s risk decreases, so it demands a smaller premium. A poorly rated company can thus still borrow money.
From the collateral account to the margin call obligation
The most common case is cash collateral. One side transfers an amount into a collateral account that belongs to the other side if something goes wrong. Instead of cash, government bonds are often used because they are considered particularly safe. However, the value of these securities fluctuates, so usually more is posted than necessary. This discount is called a haircut.
The value of a transaction changes constantly. That’s why it is recalculated daily who owes whom how much. If the exposure increases, the other side must post additional collateral. This top-up is called a margin call. Whoever cannot meet it will have their position forcibly closed out.
All of this is regulated in a contract annex, the Credit Support Annex, or CSA for short. It specifies which securities count as collateral, how often calculations are made, and above what amount a top-up must be posted. A related but different term is a guarantee: there, a third party is liable, instead of assets being pledged.
Where the term appears in the news
Credit support becomes most visible in crises. When prices collapse, margin calls become due across the board. Sales to raise cash push prices down further. This chain reaction significantly accelerated the 2020 coronavirus crash in the stock markets.
The topic is also prominent at crypto exchanges. There, positions are automatically liquidated as soon as the posted collateral is no longer sufficient. Billions can disappear within minutes this way. The principle is the same as with banks, only faster and without oversight.
For technology companies, credit support plays a role in building data centers. Such projects cost billions and are financed through loans. Lenders then demand guarantees from the parent company or a lien on the facilities. In reports on AI investments, it therefore regularly comes up who is liable for which amounts.