Acquisition of Credit Suisse - Background and Outlook
The stability and prosperity of the Swiss financial centre are central to the entire Swiss economy. The takeover of Credit Suisse by UBS and the measures taken by the Swiss authorities have far-reaching implications for the Swiss financial centre. In the view of the Swiss Bankers Association (SBA), they were targeted and effective in ensuring the stability of the Swiss financial centre and building confidence. Switzerland has therefore assumed responsibility for preventing the spread of an international financial crisis and establishing stability. Based on the information available and numerous discussions with experts, the Swiss Bankers Association (SBA) comments on the solution found as well as on current political affairs and issues.
The Swiss Bankers Association’s position
Analysis of the events
Spring 2023 marked a turning point for the Swiss financial centre. Let us first recall the positive aspects. Almost all Swiss banks had reported solid full-year results for 2022 in spite of various macroeconomic headwinds: even with the slump at Credit Suisse, total net income for all banks in Switzerland was CHF 70.2 billion. This was only slightly below the year-back figure, itself the best recorded since the financial crisis. Headcount across the industry as a whole actually rose by 1.6% last year. This good performance allowed the banks in Switzerland to build up their capital underpinning steadily, and help their customers develop their businesses and harness the potential of sustainability and the digital transformation. The industry thus started 2023 on a very sound footing, and the generally positive interim results show that this trend has continued. Now the bad news. The country’s second-largest bank experienced an existential crisis of such proportions that it had to be rescued through concerted action by the authorities and UBS over the weekend of 18 and 19 March. While this decisive response served to secure financial stability and the uninterrupted supply of financial services to businesses and the general public, the downfall of Credit Suisse raises some important questions.
Politicians, the authorities and UBS / Credit Suisse themselves have not yet completed their in-depth investigations into the causes of the crisis and how to address them, but it already seems clear that decisions made within Credit Suisse over many years placed the bank in a highly vulnerable situation for which it only had itself to blame. Following the Archegos and Greensill affairs in particular, the bank’s financial losses and the loss of trust in its business model and ultimately in its overall stability became so pronounced that it was forced to recapitalise on several occasions, saw its room for manoeuvre drastically restricted and finally fell victim to a bank run in two large waves in October 2022 and March 2023. Credit Suisse was left exposed to external factors that triggered a chain reaction, which ended up prompting the bank’s management to concede that it could no longer survive on its own. The financial market had already realised by 2021, if not before, that the outlook for Credit Suisse was grim. However, there is clear evidence that the roots of its downfall can be traced back much earlier to developments that took place over a period of years within the existing regulatory and accounting systems, overseen by the bank’s Board of Directors and auditors, the Swiss Financial Market Supervisory Authority FINMA and the Swiss National Bank (SNB).
Banks fulfil the economically vital function of money creation. The fractional reserve banking system is in widespread use around the world, and with great success. It is extremely efficient from a macroeconomic viewpoint, but it does also entail risks due to the transformative function of a bank’s balance sheet, which enhances this efficiency. The sudden withdrawal of a significant proportion of deposits can lead to a severe crisis. Banks must hold enough liquidity and capital to cover these risks, and each bank’s management must ensure that its business model is sustainable and its risk management robust. Nevertheless, even if they meet all the applicable requirements and practice sustainable management, situations may occur in which liquidity outflows are so large that the central bank has to intervene as the lender of last resort – a role that is absolutely integral to the fractional reserve banking system. However, when an institution-specific crisis threatens to spiral into a systemic crisis with potentially devastating consequences for the national economy, it is essential for the SNB to have a broad range of flexible financial and communication tools at its disposal that it can employ immediately to avert or at least contain systemic risks.
At any rate, trust is always indispensable to a fractional reserve banking system, and losing it can prove fatal. This is common knowledge, which is why supervisory authorities are tasked with keeping track of the level of trust investors, creditors and customers place in a bank in addition to capital and liquidity metrics and other aspects. Since trust cannot be precisely quantified, much is left to the discretion of the authorities, in particular FINMA, which can intervene pre-emptively when they identify a loss of trust. There had been signs of a dangerous loss of trust at Credit Suisse for some time, and the question of how FINMA and Credit Suisse’s management dealt with these needs to be answered.
The threat posed by bank runs and their self-sustaining spiral of momentum has been known about for a long time. What is new and especially striking in the case of Credit Suisse is the speed at which these chain reactions can occur as a result of the digital transformation and the rapid dissemination of information via social media in conjunction with traditional media. A bank run can now happen digitally at any time and can take on dangerous proportions in the blink of an eye. This presents us with an entirely new challenge. At the same time, however, the risk of a bank run is small for a well-managed bank with a sustainable business model. While it can hit any bank very hard and very suddenly, therefore, it is unlikely to do so without warning. Trust in the bank and its management plays a key role here. The occurrence and severity of a bank run are thus not the cause of the problem but symptoms of the crisis of confidence reaching a critical point.
Interest rates have shot up due to sharply rising inflation in the US and Europe, lending a renewed boost to the income of banks that focus on interest margin business and thus increasing the overall resilience of the system. At the same time, however, this has caused banks with a poor grip on interest rate risks – first and foremost Silicon Valley Bank, together with other medium-sized US banks – to collapse. With markets already experiencing jitters, reports of these banks’ acute problems increased the systemic risk of a global financial crisis, especially across the weekend of 11 and 12 March 2023. For banks like Credit Suisse, which had already experienced a serious loss of confidence in its business model, this very quickly made the economic environment much more challenging. On top of this, the US authorities announced on Sunday, 12 March that all deposits at the stricken US banks as well as other banks would be protected. This brought a certain amount of temporary relief to the US banking industry but further increased the pressure on Credit Suisse and other banks.
FINMA and the Competition Commission (COMCO) are clarifying the possible impact on competition. The SBA is committed to effective competition and open markets. As things stand today, Switzerland, with its approximately 230 banks and generally very open markets for most client groups, is experiencing intense competition for a large number of banking services. If constellations develop for certain activities, such as in the interbank and corporate banking business, whereby questions arise about sufficient access to specific services, it is up to FINMA to make the necessary clarifications together with the Competition Commission.
Switzerland is home to numerous internationally oriented companies that are successful worldwide with their products and services, operate globally and want to conduct their business via the Swiss financial centre. In order to satisfy the trade and financing needs of the Swiss economy as effectively as possible, internationally oriented banks with a broad range of services are needed. Such banks therefore have a high economic value.
Without major Swiss banks, access to the international capital markets for internationally oriented Swiss companies and the banks themselves would depend entirely on foreign countries. This also applies to the availability of highly qualified home-grown professionals with the right know-how to the entire financial sector. In a wide range of sectors (e.g. energy, pharmaceuticals), the crises of recent years have led to considerable efforts being made to bring production capacities back to Switzerland with a view to ensuring security of supply. It is not clear why regulatory intervention should only increase dependence on foreign countries in the banking sector. If Switzerland wants to play the role of an international financial centre, it needs at least one large international bank.
This raises the question of the extent to which politicians and the business community are willing to allow domestic offerings to be supplanted by foreign ones, thereby increasing the number of dependencies and putting the global profile of the financial centre, and therefore the economy as a whole, on the line. It should also be mentioned that the merged bank is about 40 percent smaller than UBS alone was before the financial crisis, while Switzerland's economic output has grown by a quarter in the same period.
What does this mean for regulation?
SBA is committed to an open-ended review of the events and government measures. In particular, this review should examine whether existing regulation was not sufficient to prevent the events that occurred or whether it was not applied in a timely and/or targeted manner. It will show whether and in which areas, if any, there is a need for stricter regulation.
The review should take into account the fact that the numerous and diverse players in the Swiss banking centre have, on the whole, successfully undergone a fundamental regulatory transformation in recent years and have learned the right lessons from the financial crisis. For example, nowadays all banks have significantly larger liquidity and capital buffers. The Swiss banking centre is therefore also well positioned by international standards. It is important to emphasise that the regulations implemented in the last decade and the measures taken have been fundamentally effective. This is demonstrated by the fact that Credit Suisse is the sole bank – albeit a significant one – that has run into difficulties. The other 230 or so banks in Switzerland, on the other hand, are generally stable and robust, and perform good work every day in the interest of their clients.
The Swiss capital adequacy requirements for systemically important banks, while aligned with international standards, are already strict in comparison with rival financial centres, and Basel III makes them even stricter. In particular, they are far more rigorous that other countries’ regulations with regard to the leverage ratio.
In its most recent evaluation report, the Federal Council judged the Swiss capital adequacy requirements for systemically important banks to be appropriate. Overall it is it clear that the requirements placed on Switzerland’s big banks in terms of Total Loss-Absorbing Capacity (TLAC) in particular are generally higher than those imposed on comparable institutions in the EU, UK and US, most notably as regards the leverage ratio.
A sizeable capital buffer strengthens the TLAC, reduces the risk of bank runs in cases like this and provides a more solid basis for resolution or turnaround measures. It is worth noting here that it was precisely UBS’s strong capital underpinning, flanked by measures taken by the SNB and the federal government, that made it possible to avert a nationwide crisis that could have had international repercussions. UBS was of course subject to the same rules as Credit Suisse, and the market clearly views it as strong enough to absorb the latter following the takeover. This tells us a lot about the suitability of the existing regulatory requirements and the responsible way to handle them. The liquidity and loss protection guarantees provided by the State were key support measures to ensure additional stability during the transition phase. The example of UBS thus demonstrates that a solid capital base is essential in providing a buffer and buying time to overcome crises, while the example of Credit Suisse proves that such a buffer can never offer total crisis protection, especially if the business model is not sustainable and risk management is not robust.
From a macroeconomic perspective, it is important to remember that substantial increases in capital adequacy requirements would have a noticeable impact on the real economy. They could unintentionally lead to a credit crunch by reducing lending volumes and increasing costs. Aided by its members, the SBA worked out, for example, that raising the minimum leverage ratio to 15% would increase the cost of borrowing by up to one percentage point, all other things being equal. Based on current interest rates, this could amount to as much as a 50% increase. The extent to which this cost would weigh on the overall economy would depend on the prevailing market situation, but it would certainly have a negative impact, and mortgages would be affected as well. Another significant increase in capital adequacy requirements would thus hardly benefit the national economy, especially since it would not address the causes of the current crisis. Instead, this misguided approach would curtail the banks’ economically vital function as lenders and thus also the real economy, jeopardising the whole country’s prosperity. Inevitably, there would also be a risk that some of the banks’ business might move to unregulated industries, which could further increase the systemic risks.
The “too big to fail” (TBTF) regulations have proven their worth in the real world in a number of key respects, so it would not be fair to say that they do not work. Some of the fundamental TBTF tools (e.g. liquidity requirements, loss-absorbing capital instruments, structural requirements and operational preparations) helped to mitigate the systemic risk emanating from Credit Suisse, even though the authorities opted against resolution. The existing regime also gives the federal government a certain amount of scope to support a solution that makes more macroeconomic sense than resolution, and that is exactly what it did. A sale is thus a viable option. The takeover of Credit Suisse by UBS was seen by all concerned as the most effective means, given the circumstances, of preventing the collapse of Credit Suisse and the international repercussions it would have. Resolution under the TBTF rules would have been a conceivable option, but it was not prioritised because the takeover by UBS, supported by measures from the authorities, offered a much better alternative for the economy as a whole.
An effective remuneration system rewards staff for their performance and thus creates incentives for long-term productivity, efficiency and optimum customer service in the interests of all stakeholders. It also creates incentives for responsible risk management and discourages excessive risk-taking. Variable remuneration is integral to such a system and is used in all sectors of the economy. However, as stated in FINMA Circular 2010/1 “Remuneration schemes”, any variable remuneration component should be reduced to a minimum if a company makes a loss. The circular also sets out a number of other key principles concerning the remuneration system as a whole, responsibilities etc. and thus provides an adequate framework for this purpose. With this in mind, the SBA expects its members to comply with the circular, especially its requirements for staff to bear a share of any losses incurred and for companies to apply sustainable criteria. SBA members are also expected to observe the principles set out in the Swiss Code of Best Practice for Corporate Governance.
In view of the negative trend in Credit Suisse’s share price, the bank’s staff have lost deferred variable remuneration totalling more than CHF 2 billion, which equates to a reduction of almost 80% in this component of their pay. In addition, the Federal Council decided that, as part of the takeover, this deferred variable remuneration would be cancelled entirely for the Executive Board and reduced for managers in the first and second levels below. This affects some 1,000 Credit Suisse staff worldwide. Nevertheless, despite what were already lengthy deferral periods in line with the FINMA circular, some managers who had left Credit Suisse before it was taken over will not be financially disadvantaged to the same extent, and some will not be affected at all. This remuneration system, therefore, does not necessarily target those who were actually responsible for the problems, particularly given high staff turnover. This is why the Federal Council ordered Credit Suisse to look into the possibility of reclaiming variable remuneration already paid out to members of the Executive Board and submit a report on the subject to the relevant authorities. It is important to ensure that the necessary conclusions are drawn from the report’s findings.
At any rate, an effective system must provide for remuneration to be commensurate with the balance between risks taken and returns generated, taking account of costs and capturing a high level of detail. The extent to which action is needed here remains to be seen, but it is vital to examine precisely how the figures that flow into the remuneration process come about rather than just looking at the system itself.
The idea of a segregated banking system (i.e. one in which commercial and investment banking are separated by law) was considered in the wake of the 2007/08 financial crisis but ultimately rejected due to a lack of proof that it would make the financial system more stable. Lehman Brothers, for example, was a pure investment bank, and Silicon Valley Bank a pure commercial bank with no investment banking operation. Moreover, it was actually investment banking that lent stability to the Swiss universal banks during the banking crisis of the 1990s, when their retail business faltered. There are thus no grounds at all to conclude that segregating the two lines of business would add stability to the financial system overall or prevent any individual bank from experiencing a crisis. On the contrary, the universal bank model offers benefits in terms of stability through higher diversification, and segregation would sacrifice these for no obvious gain.
What is more, a bank’s risk profile is not simply determined by the fields in which it operates. It depends on specific transactions and the assets and liabilities arising from them. Prudential regulation must therefore focus on the risk profile rather than the line of business, and this is exactly what it currently does. Another key consideration from the systemic perspective is that a bank’s operations must be rigorously geared to customers’ needs, with risks appropriately limited, clearly disclosed and kept under control.
The universal banking model offers a range of advantages in this respect for the benefit of customers. A diversified capital markets business is in the interests of other industries. An integrated universal bank can offer companies a broad range of services. If investment banking services cannot be provided in Switzerland either inside or outside a bank, this is highly detrimental to customers who need them. Access to the international capital markets would depend entirely on foreign operators. Keeping a globally active Swiss universal bank is therefore vital to the international profile and competitiveness of the entire Swiss economy, and it also ensures the availability of key services for other banks. A broad and diversified financial market with a variety of universal bank-style players of different sizes is very important to both the overall economy and system stability. That said, investment bank operations must always be aligned with each bank’s core business and its customers’ needs.
The SBA supports the introduction of a “public liquidity backstop” as a mechanism for further strengthening the systemic stability of the Swiss financial centre. This new “third line of defence” is intended to complement existing instruments that serve to protect the banks’ liquidity, as well as the SNB’s Emergency Liquidity Assistance (ELA). Comparable instruments are already established in comparable financial centres and are part of the standard package of instruments used internationally to prevent crises.
The role of the authorities
As mentioned, the financial market picked up on the problems at Credit Suisse some years before events took over, and the difficulties with governance and the business model dated back even earlier. To gain a sufficiently accurate picture of how the authorities assessed the situation at Credit Suisse, how they worked together and intervened, it is therefore necessary to look back over a longer period. Still, the situation at Credit Suisse must have been rated as critical by October 2022 at the latest. Equally, the decision regarding the takeover of Credit Suisse by UBS had to be taken within a very short time. It remains to be seen whether, in preparing for and managing the crisis, the authorities established the facts they needed and evaluated possible courses of action in good time.
The combination of a systemically important bank in difficulties and a nervous global financial market increases the systemic risk, and with it the SNB’s degree of responsibility. It is the SNB’s job to maintain financial market stability, and it is the only body with the funds to effectively contain impending systemic risks in a crisis. It is difficult to gauge from outside how much scope there is for optimising the dynamic balance of responsibility between the SNB and FINMA. Areas to consider include which supervisory authority is empowered to intervene at a given time, what rights and instruments it has at its disposal, and when it is possible, preferable or essential to apply them. That also includes communication with the public. Another question still to be answered is what options FINMA considered or rejected as regards activating TBTF instruments, when that was done, and why.
Statements by FINMA to the effect that in the case of Credit Suisse, it was unable to bring about any fundamental change of conduct even after numerous enforcement proceedings raise questions regarding the authority’s ability to enforce its powers and the resources available to it. There is no indication that the instruments available to FINMA across the banking sector as a whole need to be expanded; indeed, where non-systemically important banks are concerned, FINMA appears to employ all the instruments in its armoury. However, in the particular case of Credit Suisse, it seems there were limits to the enforceability of the rules themselves, or FINMA’s ability to enforce them.
Credible and effective financial market supervision is key to a successful and morally sound financial centre. The review of the events will have to show to what extent the existing regulation was not sufficient to prevent the events that occurred, or whether it was not implemented in a timely and/or targeted manner. It will show whether and where new or expanded FINMA instruments and powers are appropriate. FINMA already has a wide range of possible instruments at its disposal. For example, FINMA can penalise breaches of the requirement to guarantee irreproachable business conduct ("guarantee requirement") and impose industry bans (Art. 33 FINMASA) or activity bans (Art. 33a FINMASA). With the withdrawal of guarantees, FINMA's powers of intervention already go very far, and it has made increasing use of them in recent years. However, it does not have the power to issue fines (as some foreign supervisory authorities do). The existing FINMA powers (FINMA-Circular 2017/1 Corporate Governance; Circular 2013/8 Market Conduct Rules and Circular 2010/1 Remuneration Schemes) should be analysed, especially with regard to their implementation and enforcement. Accordingly, the Federal Council has recommended Postulate 21.3893 “Lean tools to better hold top financial market leaders accountable” for adoption and is of the opinion that the existing instruments should be subjected to an efficacy analysis within the framework of a report featuring an overview in accordance with the postulate.
When a bank’s market value is systematically and substantially below its book value, that points to a lack of investor confidence in its business model and to potential fragility. In a situation such as this, it is vital to intervene before the systemic risk rises excessively. Consequently, the authorities responsible must be able to identify a development of this kind at an early stage and take it into account in their work. If it is allowed to go on for too long, the probability of a market solution declines and the systemic risk rises further. The trend in Credit Suisse’s share price and then its credit default swap spreads had been flagging this situation up for some time. This suggests that business performance, internal complexity, reputation, legal risks and the ability of management to implement corrective measures should play a much greater role in the supervisory authorities’ assessment. In principle, it must be clear that only an array of metrics and information can paint a sufficiently comprehensive picture of a bank’s condition; a single metric can send important signals, but its simplicity means that potentially relevant aspects are disregarded. A measure such as the regulatory leverage ratio, for example, is quite appealingly simple, but that very fact means that similar risks can lead to widely differing valuations, or that the ratio is distorted by risk-free items. The leverage ratio on its own, therefore, is limited in its meaningfulness, and should always be read in conjunction with the risk-weighted Tier 1 capital ratio. Moreover, financial market data and information can provide indications of the soundness of a bank’s business model or risk management, and are therefore important quantitative and qualitative complements to regulatory metrics and supervisory activity in general.