Too big to fail (TBTF) – the Federal Council report on banking stability
A competitive and stable financial centre is vital to a flourishing economy and Switzerland’s prosperity. It is therefore essential to learn the right lessons from the demise of Credit Suisse. The bank’s downfall was mainly due not to a systemic failure but to a lack of confidence in management’s ability to steer it onto a course of sustainable profitability. While the banking sector as a whole was thoroughly robust, the failure of Credit Suisse was years in the making.
This is the background against which the measures put forward by the Federal Council in its report must be viewed. While some will help to promote stability and competitiveness, others actually put those assets at risk. Fundamental principles are also breached in a number of areas. After careful consideration, a range of potential measures needs to be selected for appraisal with a view to targeted and measured implementation, having regard to the bigger picture.
In brief
We believe the following conditions and overarching principles to be central:
We share the Federal Council’s view that requirements must be geared to banks’ size, complexity and risk profile. This proportionate approach must reflect the fact that Credit Suisse was the author of the its own demise. If this were not the case, we would not be discussing any additional measures, let alone ones that could impact all banks. Using the self-inflicted downfall of a single bank as a pretext for a wide-ranging wave of regulation would be wholly disproportionate. The measures adopted must therefore be clearly graded to match the various supervisory categories, and a healthy dose of pragmatism is needed.
Due account must be taken of the specifics of institutions’ legal forms, legislative mandates and rules. For example, it makes no sense to impose rules on responsibility and remuneration on banks whose partners already have unlimited liability or that are majority owned by a family. Likewise, requirements regarding corporate governance rules depend on the banks’ ownership and legal structure. Finally, legislative mandates at federal and cantonal level as well as other provisions must be respected.
The Federal Council itself states that its aim is to enhance accountability among those in charge. However, some measures are incompatible with this aim and therefore put it at risk, one example being certain ideas regarding early intervention by FINMA.
Some measures are designed to neutralise procyclical elements. This is to be supported in principle. Others, however, threaten to introduce procyclicality: these include ideas on Pillar 2 capital surcharges and legally enshrining market indicators to trigger early intervention by FINMA.
The Federal Council report examines the stability of the banking system as a whole. All the measures it proposes must therefore be assessed, selected and calibrated accordingly. However, the Federal Council proposes a drastic timetable in which those elements covered by an ordinance would be implemented much sooner than the others. This makes an integrated perspective impossible and must therefore be rejected.
Giving FINMA a role as an investigating and sanctioning authority is problematic from a rule-of-law point of view. The report also proposes placing banks at a disadvantage vis-à-vis other litigants in ordinary administrative proceedings. This would mean that fundamental principles of procedural law would cease to apply to a single group of economic actors. Such special rules are questionable from a rule-of-law perspective, especially given that there are less drastic ways of, for example, speeding up legal proceedings. On the other hand, special rules in financial market law are appropriate and expedient where FINMA has specific powers that do not exist elsewhere in the legal system. Separate rules of procedure, or at least a clarification of how the existing rules apply, are required here to provide legal certainty, preclude arbitrary “naming and shaming” and therefore prevent trial by public opinion. Additional powers for FINMA must therefore be evaluated and circumscribed carefully.
Many of the measures proposed have little relevance to the actual causes of Credit Suisse’s demise. Moreover, potentially crucial facts will not be established until the parliamentary investigation committee’s report has been published. For this reason especially, it is essential to wait until the report is available before the necessary task of setting priorities is undertaken.
The effectiveness of the various measures and their overall cost must be clearly set out in the form of a regulatory impact assessment. Their cost/benefit ratio is an essential consideration when prioritising and structuring them. Implementing them, and imposing stricter requirements where necessary, must not impede competitiveness. Great importance must therefore be attached to consistency with international standards, as well as alignment with rules in other comparable financial centres.
In our view, these requirements and principles necessitate the following thematic priorities:
The crisis surrounding Credit Suisse has demonstrated the importance of robust, optimally broad-based arrangements to secure liquidity. One element of this is sound liquidity management within banks. Another is that all banks, provided they are solvent and meet certain conditions, should be able to receive fast and flexible liquidity assistance from the SNB against readily available and transferable collateral, in particular when they are no longer able to refinance their operations on the market. Liquidity provision in this form does not require a state guarantee, makes a vital contribution to safeguarding system stability, and thereby significantly reduces the risks to the nation as a whole. Thirdly, Switzerland should have a PLB available to support the restructuring of a systemically important bank, in the interest of system stability.
The Swiss Bankers Association therefore supports the Federal Council’s recommendation to introduce a PLB for systemically important institutions, complementing the existing tools to preserve system stability. Similar instruments are already in place in comparable financial centres, are part of the standard toolkit available internationally, and are recommended by the Financial Stability Board (FSB). Since the PLB is protected by an extensive bankruptcy privilege for the SNB, there is no automatic entitlement to it, and substantial interest and premiums would have to be paid to the federal government by any institution benefiting from it, we see no logical justification for additional lump-sum compensation.
The Swiss capital requirements for systemically important banks, while aligned with international standards, are already strict in comparison with rival financial centres, and will become even more so when “Basel III Final” comes into force in 2025. In particular, they are far more rigorous that other countries’ regulations with regard to the leverage ratio.
A sizeable capital buffer strengthens the total loss absorbing capacity, reduces the risk of bank runs in cases of this kind, and provides a more solid basis for resolution or turnaround measures. A solid capital base is thus essential in creating trust, providing a buffer and buying time for crisis management. However, it can never offer total crisis protection, especially if the business model is not sustainable and risk management is insufficiently robust.
From a macroeconomic perspective, it should also be borne in mind that substantial increases in capital requirements would have a tangible impact on the real economy. They could unintentionally lead to a credit crunch by reducing lending volumes and/or increasing costs.
A significant, across-the-board increase in capital requirements therefore offers no macroeconomic benefits, especially since it fails to address the causes of the crisis in question. It is a misguided strategy that curtails the banks’ macroeconomic role, with the concomitant impact on lending in the economy and thus the prosperity of all. It could also result in some of the banks’ business moving to unregulated industries, further exacerbating systemic risks.
In its report, the Federal Council points to the weak capitalisation of Credit Suisse’s parent bank, which FINMA accepted by granting capital discounts at standalone level. As a consequence, it calls for stricter standards at individual institution level and wants the power to impose and disclose capital surcharges as necessary. Any proposals in this area will have to be assessed with care.
It is crucial to a bank’s risk management that the responsibilities of decision-makers be clearly defined and their remuneration aligned with the risk policy, the bank’s long-term performance and compliance with codes of conduct. We therefore support targeted amendments in the areas of corporate governance, responsibility and remuneration, subject to compliance with the overarching principles set out above. FINMA Circular 2010/1 “Remuneration schemes” already sets out the key principles of a sustainable remuneration policy. To add greater weight to the circular’s content and make it more binding, we support the strengthening of certain legal bases for remuneration systems. As a complement to the existing proper business conduct requirements, we also favour the introduction of a lean, proportionate and pragmatic accountability framework (“senior managers regime”). To be strictly proportionate, however, these more precise rules should be aligned with the size, complexity, risk profile and business model of the institution concerned, and should also take account of the legal form as well as any legislative mandates. For that reason, we see absolutely no reason for additional requirements in respect of the vast majority of institutions.
Effective banking supervision results from a combination of legal bases and specialist expertise with a measured and bold approach to implementation. Merely expanding or tightening up the law will not make up for any shortcomings in the other three areas.
Efficient collaboration between the Federal Department of Finance (FDF), the Swiss National Bank (SNB) and the supervisory authority (FINMA) is key. The parliamentary investigation committee is currently working to establish how far this was the case during the Credit Suisse crisis.
The supervisory authority’s approaches to recovery and resolution in particular must be analysed and updated as necessary. For example, an increased focus on the practical feasibility of recovery and resolution plans in various crisis scenarios is something worth considering.
Conclusion
We are highly critical of some of the measures in the round. Firstly, the measures on capital adequacy must be assessed in their entirety, and must not needlessly restrict competitiveness. Secondly, when considering additional powers and resources for FINMA, ideas on expanding the power to impose fines, early intervention by FINMA at banks, the abolition of legal remedies, the use of audit firms and even doing away with dual supervision, critical scrutiny is required. Likewise, given FINMA’s demand that it should be allowed to publish enforcement proceedings, there needs to be a careful examination of why the existing business conduct requirement and the interventions and communication it entails are not enough. In any event, clear rules justifying the publication of enforcement proceedings need to be put in place. Thirdly, certain ideas concerning accountability and cost/benefit ratios are potentially much too far-reaching, especially those on strengthening recovery and resolution planning for parent banks. Fourthly, no specific requirements should be introduced for matters where the cause is unrelated, such as those concerning the provision of liquidity information.
The SBA supports targeted measures that demonstrably improve system stability and are clearly pertinent to the Credit Suisse crisis. At the same time, fundamental regulatory and rule-of-law principles, as well as proportionality, must be safeguarded.
All measures must also be evaluated in their entirety. Different timings for different measures cannot be agreed until it is clear which of them are to be implemented and in what form.
As the umbrella organisation of banks in Switzerland, the SBA argues for open and fact-based debate. It is committed to maintaining proportionality, competitiveness and stability, and will continue to contribute constructively to work on evaluating the regulatory framework.