SWISS BANKING : SYSTEMIC RISK ? / THE ECONOMIST

Systemic risk?

Jul 20th 2009

From The Economist Intelligence Unit

The size of Switzerland's big bank pose a risk to the economy


The latest financial stability report from Switzerland's central bank highlights the continued systemic risk posed by the disproportionate size, relative to the economy, of the two largest Swiss banks and warns of the ongoing risk of losses leading to capital depletion. In time, financial services regulation is set to see significant changes, including mooted powers to regulate banks' size and raise capital ratio requirements, but in the near term UBS will remain a concern for regulators, with attention focused on its balance sheet position and an impending US lawsuit.

At its last quarterly meeting in June the Swiss National Bank (SNB, the central bank) confirmed the continuation of its current expansionary monetary policy stance, based on its assessment that the balance of inflationary risks remained clearly skewed to the downside. Apart from leaving interest rates at an extreme low—with the target band for the Swiss franc three-month Libor at 0-0.75% and the central target at 0.25%—this means that its quantitative easing programme will continue, as will its efforts to prevent any marked appreciation of the Swiss franc.

The main point of interest at the meeting was the SNB's view of the banking sector, as part of its annual financial stability assessment. The issue is highly topical given the significance of the banking sector in the Swiss economy, the ongoing financial crisis, and in particular the problems surrounding UBS, the country's largest bank.

Too big to bail?

SNB data show that at the end of 2008 the Swiss banking sector's total assets of Swfr4.3bn (US$4bn) relative to its GDP constituted a ratio of 8.2, compared with Belgium (6.3), the Netherlands (5.3) and the UK (4.3). Market concentration is also high in Switzerland, with the assets of the country's two largest banks accounting for 73% of the total. The SNB's sober assessment of the stability of the Swiss banking sector noted the material risks in the big banks' books and highlighted that in an adverse scenario of a deep and protracted recession (which, as time goes on, could soon resemble more of a baseline scenario), large losses could lead to a depletion of banks' capital. This would in severe cases require a recapitalisation of the banks, possibly by taxpayers, to ensure that solvency is maintained.

The SNB issued a number of recommendations, particularly relating to the problem of banks that are considered "too big to fail". The SNB is seeking measures that will strengthen its position as financial regulator. The measures include a further reduction in banks' risk positions, a further strengthening of their capital base, the preservation of an adequate liquidity cushion and efficiency gains through restructuring, which are to be monitored by both the financial markets regulator, FINMA, and the central bank.

The SNB implicitly referred to the possibility of a collapse of one of the large banks in its analysis of the "too big to fail" problem. The central bank believes that the authorities would act to prevent such a scenario in the short term, because of the resultant systemic risk, but, in contrast to the rather lily-livered approach towards re-regulation being adopted in the UK and US, is now demanding a medium- to long-term reduction in systemic risk. In a fairly interventionist approach, the SNB announced that in conjunction with FINMA, it would examine measures to facilitate the winding-down of large international banks and would consider direct and indirect measures to limit their size. In this regard, it listed stricter capital and liquidity requirements or a direct cap on size, for example through a limit on market share or on the balance sheet/GDP ratio.

Elephant in the room

The largest Swiss bank, UBS, remains central to the SNB's concerns about systemic risk, as it battles problems on both the financial and legal-political fronts. The US Internal Revenue Service is suing the bank for the release of details of 52,000 accounts of US clients. On July 13th—the day the trial was set to begin—the case was delayed for three weeks at the request of both sides, amid ongoing efforts by the Swiss and US governments to reach a settlement, in recognition that the affair goes beyond mere legal considerations—a court victory for the US would substantially weaken UBS, but could also influence how Switzerland handles changes to its banking secrecy.

Ahead of the trial, both sides have been submitting statements to the court. A US declaration that UBS would be able to hand over account details without committing a crime in Switzerland has been rebutted by the Swiss side, which argues that Swiss law precludes such an action. The Swiss government followed this up by declaring that it would actively prevent UBS from handing over the client data, even if the bank were ordered to do so by the US court.

Meanwhile, UBS's financial woes continue to weaken the bank's position. In late June the company announced that it would record another quarterly loss in the second quarter of 2009 (at a time when the giants on Wall Street, Goldman Sachs and JP Morgan, are presenting highly profitable results) and that the net outflow of funds under management had continued, an unsurprising development in light of ongoing negative publicity for UBS and fallout in connection with the pending US court case.

Many of the problems now stem from private banking. The losses, scandals over bank secrecy, and the threat that UBS could become more open to scrutiny are making wealthy people flee: money has been leaving the asset management and private banking arms since the start of 2008, with net outflows in the third quarter above Swfr83bn. There's still no sign of that changing. In the first quarter of the year, outflows from wealth management and the Swiss banking unit totalled Swfr23bn. The crisis has dented Swiss banks' reputation badly, and risks clobbering the private banking arm that still forms the bedrock of UBS's business.

The Swiss authorities have already taken action to try to stabilise the country's banking sector and in particular UBS. This took place through the purchase of UBS's illiquid assets by a specially established fund controlled by the SNB, initially capitalised to the tune of US$60bn. So far, US$37bn of this has been used. With the SNB now striving to force up the banks' capital adequacy ratios, and with losses set to continue against a bleak economic outlook, more may well be needed.

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