Speech
Embargo
9 November 2023, 6.15 pm
A pillar of financial stability - The SNB's role as lender of last
resort
Alumni WWZ Basel
Martin Schlegel*
Vice Chairman of the Governing Board
Swiss National Bank
Basel, 9 November 2023
© Swiss National Bank (speech given in German)
Ladies and gentlemen
Today is 'National Future Career Day', when girls and boys throughout Switzerland
accompany their parents to their workplace and spend the day watching them at their jobs.1 I
too had a visitor at work today, and once again I found that children bring fresh perspectives
and often ask quite fundamental questions. This is precisely what I want to do in my speech
today: to take a close look at a core task of the SNB in relation to financial stability - its role
as lender of last resort.
In this role, the SNB made up to CHF 168 billion in liquidity available for managing the crisis
at Credit Suisse this spring. Such a number is hard to grasp. It corresponds to approximately
one-third of Credit Suisse's balance sheet total at the time, or double the annual expenditure
of the Swiss Confederation.2
Why is the SNB the lender of last resort and why does it provide liquidity assistance in this
capacity? How does it provide this liquidity? What conditions does it set, and to whom does it
provide liquidity? These are the fundamental questions I want to address today, while also
taking an in-depth look at the challenges and limits involved. I will conclude by talking about
the liquidity assistance provided to Credit Suisse.
The role as lender of last resort
Acting as lender of last resort means that a central bank makes liquidity assistance available to
banks when they suddenly need substantial liquid funds which they are no longer able to
obtain on the market. It is an important part of a central bank's contribution to the stability of
the financial system.3
The reason why this role is necessary lies in the nature of the traditional banking business. On
the one hand, banks accept deposits from savers. On the other, they grant loans. In so doing
they bridge the different time horizons of their customers' needs. Households want instant
access to their deposits. However, borrowers need to be able to plan with certainty, which is
why they generally take out loans for several years, such as a ten-year mortgage for buying an
apartment. This is known as 'maturity transformation', and with it banks play a valuable role
in the economy.
The Achilles heel here is that a bank can get into distress if there are substantial withdrawals
of deposits. This is because in order to pay out large volumes of deposits at the same time, a
bank would have to realise assets. Doing so at short notice would incur losses, if it is even
feasible at all. For example, a bank cannot simply demand early repayment of the ten-year
mortgage mentioned earlier. And although securities can be sold, doing so in large quantities
in a 'fire sale' is often only possible at a discount. High outflows thus threaten a downward
spiral towards insolvency. Other banks can then also be caught up in the crisis of confidence,
giving rise to the risk of a financial crisis.
A lender of last resort can interrupt such a downward spiral. Liquidity assistance can allow a
bank to pay out deposits without getting into distress and having to sell its assets at a loss.
How does the SNB perform its role as lender of last resort?
There has long been broad international consensus on this fundamental role of lender of last
resort. How does the SNB perform this role in practice?
It does so by granting emergency liquidity assistance, or ELA for short. Specifically, this
means that a bank which is no longer able to refinance its operations on the market can obtain
emergency liquidity from the SNB. The SNB gives the bank liquidity assistance in the form
of loans. The bank has to provide sufficient collateral to cover these loans.4
The SNB accepts a broad range of collateral - in particular also illiquid assets. The aim is for
banks to be able to obtain as much liquidity as possible from the SNB should the need arise.
The eligible assets primarily comprise mortgages. The SNB accepts mortgages on both
private and commercial properties in Switzerland as collateral. The focus is on mortgages
because they are generally illiquid and banks are therefore unable to realise them at short
notice. Furthermore, they are banks' most important assets by far, accounting for around 85%
of domestic credit volume.5
Systemically important banks can also use various securities as collateral. The eligible
securities can be denominated in different currencies and comprise securitisations, equities
and bonds, including those issued by borrowers with lower credit ratings. Unlike mortgages,
securities can usually be used by the banks themselves to obtain liquidity on the market.
Nonetheless, this option can be helpful to banks, particularly when key parts of the financial
markets come to a standstill, as happened in the global financial crisis.6
Here I would like to emphasise something that is frequently overlooked. You will often see
texts that simply state that central banks provide liquidity assistance. In practice, it involves a
complex apparatus with operators working under high pressure. When the SNB provides
liquidity assistance, it receives collateral from the recipient bank. This has to be checked: Has
the collateral actually been delivered and does it meet the agreed criteria? In return, liquidity
is created, transferred and settled. If the SNB provides liquidity in foreign currency, it usually
has to obtain it against its own collateral on the market or from the corresponding central
banks. In addition, legal clarifications are required, and the risks have to be monitored and
managed on an ongoing basis. Of course, close cooperation with the other authorities
involved is also necessary, particularly with FINMA and the Federal Department of Finance.
Dialogue with the commercial banks is also highly important. In an emergency, this work has
to be completed within a matter of hours. This apparatus does not run automatically. It has to
be carefully set up, maintained and tested over and again.
What conditions does the SNB set for liquidity assistance?
What conditions have to be met for the provision of liquidity assistance by the SNB? I would
like to highlight two.
The first condition is solvency. The bank must be solvent and viable, or a package of
measures must be available which ensures that the business will remain viable.7 If the SNB
were to provide liquidity assistance to an insolvent bank, this would only delay the bank's
inability to meet its obligations, not prevent it. If the bank has too many bad loans on its
books or its business model is ailing, it will need more capital or it will have to restructure its
business. Liquidity assistance is not the best medicine for such ills. More deep-seated
problems need to be resolved with other measures.
The second condition is collateralisation. The liquidity assistance must be covered by
sufficient collateral. For this reason, the SNB applies risk discounts, or 'haircuts' as they are
known. A haircut of 10%, for example, means that the SNB grants a loan of CHF 90 million
against collateral of CHF 100 million. In this way it takes into account the fact that the assets
may not necessarily fetch their full original value when sold. The SNB uses recognised
assessment methods to determine these haircuts. The haircuts depend among other things on
the type of assets concerned, the currency in which they are issued, and how well diversified
they are. For example, haircuts for a broadly diversified portfolio of mortgages are between
10% and 15%.8
The assets also have to be transferable to the SNB. To ensure transferability, banks have to
make legal and operational preparations in respect of the assets. For instance, the individual
customer contracts need to allow transfer to third parties. Furthermore, banks must be able to
ensure that the same assets are not used more than once as collateral. This preparation for
transferability may sound trivial, but in practice failure to do so can severely restrict the
volume of liquidity assistance available.
To whom does the SNB provide liquidity assistance as lender of last
resort?
A further important question is who can receive emergency liquidity from the SNB. As I said
earlier, the rationale behind the role as lender of last resort lies in the very nature of the
banking business and the aforementioned Achilles heel. Bank collapses can lead to financial
crises and cause serious harm. The lender of last resort function is therefore aimed at banks.
This is in line with the SNB's statutory task to contribute to financial stability.
Until now emergency liquidity assistance has been prepared and regularly tested with all
systemically important banks - namely PostFinance, Raiffeisen Group, UBS (including Credit
Suisse) and Zürcher Kantonalbank. The SNB is currently expanding the possibilities for
obtaining liquidity against mortgages to the whole banking sector. No matter their size, banks
can find themselves in a situation where they need significant amounts of liquidity quickly.
Having started preparations for this expansion in 2019, the SNB began the implementation
with a pilot project in 2022 and informed the general public in September this year. This
expansion will allow the SNB to provide liquidity against mortgage collateral to the whole
banking sector in the event of liquidity shortages.
As mentioned before, a prerequisite for liquidity assistance is that the collateral must be
transferable to the SNB. If only a handful of banks are involved, this can be individually
arranged, implemented and tested. The expansion to cover the entire banking sector calls for a
standardised process. Mortgage collateral will therefore be transferred digitally and in a
standardised format via the electronic SIX Terravis platform.
This expansion is open to all banks. The SNB expects banks active in mortgage lending to
take part in this initiative and prepare mortgages for transfer. Broad participation will increase
resilience to liquidity shortages both at the banks involved and in the banking system as a
whole.
To sum up, emergency liquidity assistance is currently operationally available to all
systemically important banks, with a wide range of eligible collateral. With the expansion, all
banks will now be able to obtain liquidity assistance against mortgages when needed -
provided they make the requisite preparations.
What are the challenges a lender of last resort faces?
As economics graduates, you will not be surprised to hear that the lender of last resort
function also involves trade-offs, which give rise to challenges. What are these challenges and
trade-offs?
The first trade-off concerns the disclosure of liquidity assistance. If the provision of liquidity
assistance is made public, for example due to disclosure obligations or voluntary reporting by
the bank, this sends out a signal. Ideally, this signal will create trust and calm the situation.
However, what can also happen is that the receipt of liquidity support catches the market
unawares - especially if a bank's liquidity problems are not yet widely known. This can give
rise to a phenomenon referred to in jargon as 'stigma'. For example, the emergency liquidity
granted to the UK bank Northern Rock was seen as a warning signal and triggered a bank
run.9
One possible measure to mitigate this stigma issue is to try to make liquidity assistance
commonplace. The hope then is that receiving liquidity support loses its stigma if liquidity is
obtained by banks on a regular basis rather than only being available in an emergency. Yet it
is clear that obtaining large amounts of liquidity will always sound alarm bells - even if it is
not called 'emergency' assistance. Stigma will therefore not be resolved simply by renaming
liquidity assistance.
Another measure would be to adjust the disclosure requirements so that the receipt of
emergency liquidity assistance is not immediately made public. Currently it can be the case
that both the SNB and the banks are obliged to disclose such liquidity assistance in their
regular reports or in ad hoc announcements. A delay in disclosure during a crisis would allow
time for tackling the cause of the loss of confidence. However, this would entail some
reduction in market transparency.
The second trade-off concerns the availability of liquidity assistance in relation to banks' own
provisions. When things are calm, banks finance themselves via the market and customer
deposits. If a bank finds itself in an emergency situation, the SNB stands ready as lender of
last resort. However, the availability of liquidity assistance could potentially mean banks have
less incentive to cover their liquidity in advance themselves. This gives rise to 'moral hazard'.
Just as, on the one hand, helmets offer skiers better protection, on the other hand they can also
encourage greater risk-taking and therefore result in more serious accidents.10
The interest rate terms also have to be mentioned when discussing this trade-off. The SNB
applies an interest rate surcharge for the liquidity assistance it provides. This reduces the
incentive for banks to rely on liquidity assistance. Moreover, liquidity regulations have a key
role in this regard. They limit the moral hazard and ensure that banks build up their own
buffers so that they can absorb liquidity shocks. The regulations are also designed to create
time to be able to react to increasing outflows. Nevertheless, it is of course impossible to
completely rule out losses of confidence and outflows.
What are the SNB's limits as lender of last resort?
As lender of last resort, the SNB makes a key contribution to financial stability. But what
limits does the SNB face in this role?
When addressing the question as to 'how' the SNB provides liquidity assistance, I explained
that it does so against collateral. This is not just a technical restriction, it is also an
institutional issue concerning the division of roles between the central bank and the
government - in our case the Confederation. The restriction to secured loans ensures that the
SNB's support is limited to liquidity assistance and does not become solvency support.11 The
decision on the use of public funds is the responsibility of the Confederation.
There may be cases in which a bank's collateral, even if well prepared, is insufficient for the
liquidity assistance required. If further liquidity assistance (without collateral) is still needed
to protect the Swiss economy from serious consequences, the federal government and
parliament must be able to decide what action to take and also bear the risks. This allocation
of roles in an extreme emergency is international practice.12
A proposal is currently being discussed by parliament which would complement secured
liquidity assistance from the SNB with a further form of liquidity support secured by a federal
guarantee. This public liquidity backstop, or PLB for short, takes account of the SNB's limits
and tallies with the tried-and-tested division of roles between the SNB and the Confederation.
Accordingly, the SNB supports the anchoring of the PLB in law.
Lender of last resort during the crisis at Credit Suisse
I shall conclude by returning to the crisis at Credit Suisse. How were the principles I have
mentioned reflected in the SNB's role during this crisis?
Just over a year ago, in October 2022, there were large-scale outflows of deposits from Credit
Suisse. In this phase, the bank was still able to cover the outflows using its liquidity buffers.
In March this year, there were further substantial outflows. Credit Suisse was no longer able
to cope with this second phase of high liquidity outflows on its own. The SNB provided
liquidity assistance as lender of last resort. Without this liquidity assistance, Credit Suisse
would have become unable to meet its financial obligations.
The outflows were so large that emergency liquidity assistance (ELA) was not enough. It was
supplemented by ELA+, liquidity assistance established under emergency law. Furthermore,
the Federal Council activated the PLB via emergency law to ensure the successful
implementation of the acquisition of Credit Suisse by UBS. The SNB's liquidity assistance
loan granted via the PLB was covered by a federal guarantee.
Altogether, the SNB provided up to CHF 168 billion in liquidity with these instruments. It
was the largest amount of liquidity assistance ever provided to a single bank anywhere in the
world. The amount of liquidity assistance was calculated so that it could cover virtually all
possible short-term outflows from the bank. It was provided with same-day execution in
Swiss francs, euros and US dollars when requested by the bank.
How were the two conditions of solvency and sufficient collateral applied?
As regards solvency, Credit Suisse was solvent, but was suffering from not just a temporary
liquidity shortfall but also a fundamental loss of confidence. This was why a comprehensive
package of measures was needed. Liquidity assistance alone would not have resolved the
crisis at Credit Suisse, and the package of measures addressed the underlying problems.
As regards sufficient collateral, the prepared collateral and the associated liquidity assistance
were not sufficient. The outflows were massive. Furthermore, Credit Suisse had not prepared
all the possible collateral for transfer to the SNB or other central banks.
As a result, additional liquidity had to be made available in another form. The SNB provided
ELA+, liquidity assistance introduced by the Federal Council under emergency law. This
emergency liquidity was not covered by the delivery of collateral, but instead was secured
solely by means of preferential rights in bankruptcy proceedings. In this exceptional situation,
the SNB considered the preferential rights to be sufficient for the risk incurred.
Overall, there are lessons to be learned from this crisis. In relation to the lender of last resort
function, I would like to pick out three.
The first lesson is crisis prevention. The crisis showed how quickly deposits can be
withdrawn. An important step to counteract this would be to extend the maturity of deposits.
This would reduce the risk of a large proportion of the deposits being withdrawn in a very
short space of time. The bank and the authorities would thus gain valuable time to manage a
crisis.
The second lesson is the preparation of collateral. With more extensive preparation, Credit
Suisse would have been able to receive more liquidity assistance under the existing
framework. It is therefore crucial going forward that banks prepare enough collateral for
transfer to the SNB and other central banks.
The third lesson is the PLB. Even with more preparation by banks, it is possible that their
collateral might not be sufficient to cover their liquidity needs. In such extreme situations -
when even the SNB's emergency liquidity assistance is not enough - the PLB should take
effect. ELA+ was necessary in the specific case of Credit Suisse, but it is not a model for
managing future crises. This type of loan was created as an emergency solution exclusively
for the specific crisis at Credit Suisse. The combination of ELA and ELA+ served to create
the necessary time window until a comprehensive solution to the crisis of confidence at Credit
Suisse could be worked out. However, blanket provision of liquidity assistance without the
delivery of collateral contradicts the institutionally appropriate division of roles between the
Confederation and the SNB as enshrined in law.
The crisis at Credit Suisse has shown that the SNB takes its role as lender of last resort
seriously - both in times of crisis as well as in the ongoing development in this respect over
the long term.