Philipp Hildebrand: Current state of the financial system in Switzerland
Introductory remarks by Mr Philipp Hildebrand, Vice-Chairman of the Governing Board of the
Swiss National Bank, at the half-yearly media news conference, Berne, 20 June 2009.
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Introduction
This time last year we reported that the overall market environment had calmed somewhat.
However, we also stressed that it was too early to sound the all-clear, and that there was
considerable uncertainty about the future development of the crisis. Our concerns at that
time proved more than well-founded. Indeed, the actual events outstripped our expectations.
If I may, I will start with my conclusion: the state of the Swiss and international financial
system is - and remains - vulnerable overall. Consequently, we are still maintaining close
contact with the big banks and with Swiss and foreign authorities, and are monitoring further
developments with great attention. In addition we are continuing our intensive efforts at
national and international level to improve the regulatory framework. Given the scale of the
crisis, the Swiss National Bank (SNB) is convinced that although the measures taken so far
in this area are heading in the right direction, some of them do not yet go far enough. I will
therefore begin by briefly assessing the situation of the financial system, and then present
the issues to which the SNB attaches medium to long-term priority with regard to reform of
the banking sector operating environment. In the short term, however, the main focus is on
overcoming the crisis.
Situation in the banking sector
As our Financial Stability Report published today describes in detail, the situation in the
Swiss banking sector deteriorated considerably in 2008. The turbulence in the money and
credit markets that had erupted in mid-2007 worsened in 2008, also spilling over to other
areas. The two big banks, in particular UBS, were hit hard by these negative developments.
As you know, together the two institutions recorded a total loss of some CHF 30 billion in
2008.1 They took extensive measures to strengthen their resilience. In addition to reducing
risky positions, they raised sizeable amounts of private capital. The resilience of UBS was
further strengthened by the package of government measures announced by the Federal
Council, the SNB and the then Swiss Federal Banking Commission (SFBC, now FINMA or
Swiss Financial Market Advisory Authority) in October 2008. Owing to all of these measures,
the big banks' capital situation at the end of 2008 improved slightly compared to the end of
2007, despite the massive losses incurred. However, our assessment is that, overall, risks in
the big banks' books are still material. This is all the more serious since, compared to the end
of 2007, the profit potential of the big banks is lower.
Banks with a domestic business focus, i.e. cantonal, regional and Raiffeisen banks, present
a much more favourable picture. Although the overall profitability of these bank categories
declined in 2008, it still remains above the long-term average. Their capital base is high by
historical standards and they were able to build up their liquidity reserves last year. However,
for these banks, too, the economic downturn will represent an increasing challenge.
The outlook for the banks is also shaped by the negative forecasts for the entire world
economy. These suggest a substantial deterioration in credit quality - including for
Switzerland. Consequently, increasing loan losses, substantial reductions in earnings and a
deterioration in the capital situation may be expected for a large number of banks. However,
cantonal, regional and Raiffeisen banks appear in relatively good shape to withstand these
negative developments. The situation for the big banks appears more difficult. In addition to
the still sizeable market risks, they face significant credit risks overall. Simple comparisons
with earlier crisis periods show that potential losses on traditional lending are high, when set
in relation to the capital cushion. The longer and deeper the recession, the greater these
potential losses will be.
In our basis scenario we expect the economy to recover gradually as of 2010, both
internationally and in Switzerland.
However, we cannot rule out a significantly deeper and longer-lasting recession than that
forecast in the basis scenario. In this adverse scenario of a deep and long-lasting recession,
large losses would be possible for banks with a domestic business focus as well as for big
banks. Such losses might lead to a depletion of a substantial share of the banks' current
capital reserves. This might in turn impair market confidence in their soundness.
Given this risk potential, it is therefore essential that the big banks take all the necessary
measures to ensure their resilience to any further significant deterioration in conditions.
These measures include another reduction in their risk positions, a further strengthening of
their capital base, the preservation of an adequate liquidity cushion and the alignment of their
cost structure with the changed market environment. The opportunity offered by the
somewhat calmer environment at present should be used to take these measures. The SNB
and FINMA will monitor developments in these areas closely. In this respect, the SNB
explicitly welcomes the fact that, at their last General Meetings, the big bank shareholders
agreed to the creation of authorised capital. This allows the big banks to react appropriately
and flexibly to market developments.
Regulatory agenda
However, if the stability of the financial system is to be increased in the medium and longer
term, the authorities themselves face challenges, and not just the banks. Intensive efforts are
currently going into the development of appropriate solutions, both at the international level
and in Switzerland.
Last autumn, for instance, the then SFBC issued decrees imposing tighter capital adequacy
requirements on the big banks. In future, the capital base at these institutions will have to
exceed, in good times, the minimum risk-weighted capital requirements by 100%. As a
complement to this, FINMA has also introduced a "leverage ratio", i.e. a limit to the banks'
leverage. The SNB considers that leverage of over 20 in the banking sector is not prudent
and thus is undesirable in good times. In other words, we consider that, in good times, the
capital base should account for at least 5% of the balance sheet total. This is in line with
FINMA's requirements. FINMA expects the big banks' "leverage ratio" to be well over 3% at
group level and well over 4% for individual institutions in good times. To prevent the capital
requirements from having a procyclical impact, two steps have been taken. First, there will be
a long time delay before they are implemented. The new FINMA targets will apply as of 2013
at the earliest, and an extension would be an option for the big banks if compliance becomes
impossible due to the situation on the capital markets or the big banks' individual earnings
position. Second, an anticyclical element is explicitly built into the new Swiss regulations. In
bad times, the big banks will be allowed to fall short of the new targets. In other words, a
capital cushion will be built up in good times to absorb losses in crises.
Alongside reinforcement of the capital base, liquidity also needs to be strengthened to
increase the resilience of banks. Consequently, a comprehensive revision of the liquidity
regulations for big banks is currently underway. Nonetheless, better capital and liquidity
requirements do not rule out the possibility that banks will again face existential difficulties in
the future. The SNB therefore considers all of the efforts that are going into facilitating orderly
wind-downs of large international institutions in future to be just as important. The lack of any
clearly defined and internationally coordinated wind-down procedure contributes to a de facto
obligation on the part of the state to provide assistance to these institutions. Any rescue of a
large financial institution brings more than just high costs. The "too big to fail" issue also has
a tendency to harbour incentives for banks to enter into excessive risks. In Switzerland, the
"too big to fail" question is particularly relevant and, in many respects, unique, given the
importance of the big banks for the country's banking sector and its economy. A clearly
defined and internationally coordinated wind-down procedure would help to ease this
problem. The interplay between national jurisdictions is, however, extremely complex, and
finding a solution for a predefined and internationally coordinated procedure of this kind is
correspondingly challenging and time-consuming.
The SNB therefore believes that careful consideration must also be given to alternative
approaches. These include rules governing the organisational structure of large financial
institutions. The aim of such rules would be, in a crisis situation, to split off those units of a
bank that are important for the functioning of the economy and wind down the rest. This does
not mean, however, that this type of approach would question the universal bank model as
such. The SNB is aware that rules governing the organisational structure of large financial
institutions are not easy to draw up. Legal and operational aspects would therefore need to
be analysed with the requisite care and any regulations drawn up in close collaboration with
the banks affected.
We are convinced that everything needs to be done to implement one of these approaches
for facilitating the wind-down of large financial institutions. If significant progress is not
achieved within a reasonable time frame, measures that address the size of the banks
should also be examined. One way in which the size of a bank can be influenced is through
capital regulations. Capital requirements that are dependent upon size reduce a bank's
incentive to inflate its balance sheet without restraint. Measures with a direct impact on the
size of banks are also conceivable. A size restriction would of course be a major intervention
in an institution's corporate strategy. Naturally the SNB is aware that there are advantages to
size. For this reason, the advantages and disadvantages of such a measure would have to
be examined and weighed up very carefully. Nevertheless, in the case of the large
international banks, the empirical evidence would seem to suggest that these institutions
have long exceeded the size needed to make full use of these advantages. It should be
noted that although the instrument of size restriction is far-reaching, it is by no means new in
economic policy. For decades it has been one of the tools for preventing market dominance
in the area of competition policy. Within the context of financial stability, the objective of such
a measure would be to reduce risks to the stability of the banking and financial system,
rather than to maintain competition.
I would like to run through the last few points again briefly. In the short term, priority must be
given to overcoming the crisis. However, in order to increase the stability of the financial
system in the medium to long term, we consider a reform of the operational environment in
the banking sector to be essential. We attach particular importance to alleviating the "too big
to fail" problem. Apart from stricter rules for systemically important institutions, the SNB
currently envisages two further options that it intends to examine - first, measures to
facilitate the wind-down of large, international institutions and, second, direct and indirect
measures to limit their size. The SNB will examine all of these in depth, in close collaboration
with FINMA, alongside possible further options. There can be no more taboos, given our
experiences of the last two years.
The role of the authorities
What are the lessons to be learnt from this crisis with respect to the role of the authorities? If
the regulatory progress we are aiming for is also to be enforced, we need strong authorities.
This applies, on the one hand, to FINMA, which is charged with oversight of individual banks,
or microprudential oversight. FINMA needs sufficient qualified resources to fulfil its oversight
responsibilities. On the other hand, the SNB must step up its own activities through an even
closer collaboration with FINMA and also by reinforcing our macroprudential oversight.
Unlike FINMA, the SNB does not supervise banks. We do not focus our attention on
individual institutions but on the banking system as a whole. Our macroprudential oversight is
largely complementary to the microprudential oversight carried out by FINMA. However, in
Switzerland, overlaps occur naturally between the microprudential and macroprudential
perspectives due to the systemic importance of the two big banks.
Within the ambit of its mandate, the SNB therefore considers it imperative to maintain direct
and frequent contact with the big banks. Where necessary, we will step up the frequency and
intensity of these contacts. Their purpose is to obtain information of relevance for
macroprudential oversight, but also to inform the big banks of our risk assessment. The SNB
will also become increasingly involved in regulatory projects that are relevant from a systemic
point of view. Initial examples are the work on the introduction of a leverage ratio and on the
reform of liquidity regulations, which FINMA and the SNB have been driving forward
together. This development does not essentially call into question the division of
responsibilities between the supervisory authority and the central bank. However, because of
the importance of the big banks for our financial system and our economy, greater weight
must be given to the macroprudential perspective, both in the oversight of the financial
system and in its regulation.