Politicians would do well to ask themselves how they will save the next bank in 15 years, observes finews.asia. The next crisis is not a question of if, but when.
UBS CEO Sergio Ermotti said recently following UBS's quarterly results that he will be glad when parliamentary elections are over in the fall. But that is months away, and it could be a hot summer for Ermotti and his Credit Suisse takeover plans.
Last weekend the Swiss People's Party (SVP) released a strategy paper demanding a bank never again be bailed out with taxpayers' money, which it says can be achieved by a suitable implementation of the too-big-to-fail rule.
The SVP already announced a corresponding proposal and is threatening to launch an initiative if it is rejected in parliament. The conservative party joins the numerous motions submitted to the Federal Council during a special session in April when parliamentarians of various stripes were calling for a significant increase in capital buffers to prevent a banking collapse «once and for all.»
15-Year Cycles
Given the enormous commitments made by the federal government in rescuing Switzerland's second-largest bank, such wishes seem obvious. But looking at the recent past, one concludes that's wishful thinking. It turns out the government has come to the aid of local banks three times in the past 15 years because they were no longer able to keep their heads above water.
What is notable is that the danger has always come from a new quarter, with banks seemingly finding new ways to fail from new causes.
In the 1980s, several cantonal banks took on too much risk in the local mortgage market. Then the beginning of the 1990s, state institutions were dragged into the maelstrom of the real estate crisis. The cantons of Solothurn and Appenzell-Ausserrhoden subsequently had to sell «their» banks with losses of 360 Swiss francs ($402 million) and 250 million francs respectively. The rescue of «its» Berner Kantonalbank (BEKB) cost the canton of Bern around 2.6 billion francs, while the canton of Vaud also injected hundreds of millions of francs into BCV, but was able to hold itself harmless after years of restructuring.
Paying Off
As a reaction to the measures, real estate financing was handled more conservatively, and nationally applicable rules of conduct were developed, such as carrying capacity and corporate banking.
The rescue of UBS with taxpayers' money was necessary in October 2008 for a completely different reason. In the course of the financial crisis originating in the US, it was confronted with massive losses in value on less liquid credit derivatives. The Swiss government injected six billion francs and the Swiss National Bank 54 billion francs to shore up its balance sheet. Years later, this effort paid off with the federal government making about 1.2 billion francs on loans to UBS.
To ensure such a crisis would never happen again, «too-big-to-fail» regulation was implemented, designed to allow the stabilization of a bank's balance in the event of a crisis. Yet here we are today.
No Capitalization Problem
In the run-up to the Credit Suisse rescue in March, the federal government and the supervisory authorities knew they couldn't apply these rules to the letter in the case of Credit Suisse. There was a conflagration risk to the domestic financial system, and the additional problem of billions in customer funds fleeing the bank in what essentially was a classic «bank run». This happened despite Credit Suisse being well capitalized as reflected in a hard equity ratio of more than 14 percent.
Credit Suisse needed liquidity assurances of more than 150 billion francs and the takeover by UBS to survive another day. With recent calls for bespoke implementation of too-big-to-fail regulation, politicians are responding with a recipe intended as a response to the 2008 financial crisis which ultimately proved ineffective for Credit Suisse.
Studying Blind Spots
Far better for Swiss lawmakers would be to consider where the next banking crisis could come from and how the government can position itself to intervene and save the day, and needn't involve taxpayers' money. A flexible game plan and sufficient precautions could prevent this. A fund in the style of the Esisuisse deposit guarantee could be considered, into which those in the banking industry would have to pay.
In return, the country's 230 or so financial institutions likely prefer spending money over using expensive equity to pad their balance sheets for an event last occurring in 2008.
What remains is the search for the sources of future dangers. The annual Risk Monitor of the Swiss Financial Market Supervisory Authority (Finma) could serve as a guide for creating an inventory of potential banking regulation blind spots.
Effective Flexibility
Illiquid balance sheet items, whose risks major banks are allowed to continue assessing according to their formulas, come to mind. Social media attacks, which in the case of Credit Suisse led to customers pulling billions from the bank, are another potential blind spot. Or the impact of international climate regulations on the valuation of mortgages secured by dodgy properties.
Whether Credit Suisse's bailout through a mix of sale, state guarantees, and fully writing off its AT1 bonds was the ideal approach remains to be seen. But the flexibility to deviate from rigid rules made the mix possible in the first place and has proven to be extremely effective.
