The Swiss are taking pains to make their banks as risk-free as possible to ensure client loyalty, finds Iain Morse
‘Swiss finish' might be a non-drip, sateen-finish emulsion in creamy white or vibrant red. In fact, it is the Swiss gloss on Basel III. The success of Switzerland's banking sector is of national importance. The ‘gloss' is its response to the ever more prolix and demanding regulatory environment emerging in the EU and US. ‘Swiss finish' carries a message: your money will be safer here than anywhere else. Obliged to retreat from absolute non-disclosure of client identity, here is Switzerland's response - a strategy to retain client loyalty by making Swiss banks almost risk-free.
Duly, in October 2011, the Swiss government published its proposals for implementing Basel III to domestic banks. These will be effected through amendments to the federal ordinance on capital adequacy and diversification for banks and securities dealers (CAO) and through various circulars issued by FINMA, the Swiss Financial Market Supervisory Authority. The new regulatory capital requirements in the CAO are intended to apply to all banks, including local, cantonal and mutual or co-operative ones.
This process of squeezing risk off Swiss bank balance sheets has been under way since late 2008, when FINMA ordered Swiss banks to meet minimum capital requirements between 50% and 100% above the minimum laid down in Basel II. At the same time a leverage ratio was introduced - a ratio of core capital to total assets - of at least 3% at a consolidated, group level and at least 4% on a divisional, non-consolidated level. These standards must be met by end 2013.
From 1 January 2011 the Basel ‘2.5' framework was introduced by the Basel Committee on Banking Supervision. The resulting amendments were implemented in Switzerland as amendments to the CAO, including raised capital requirements for banks, and more stringent valuation rules for assets held on bank balance sheets.
Under the Basel III regulations, the ratio of required total capital remains at 8% of risk-weighted assets. However, the make-up of such capital is changing significantly. Banks must now hold common equity tier-1 (CET1) capital of 4.5% of risk-weighted assets, up from 2% of the same. Additionally, banks must create a capital buffer of CET1 capital equal to or greater than 2.5% of risk-weighted assets. Consequently, total CET1 capital should equal 7% of risk weighted assets. An additional requirement for a countercyclical buffer of up to 2.5% of risk-weighted assets is also under consideration. The new regulations also include a leverage ratio and an internationally agreed global liquidity coverage ratio, both aimed at reducing and controlling leverage in the global banking system.
The ‘Swiss finish' added to these Basel III requirements are additional capital requirements laid out in the FINMA circular 2011/02 (Additional Swiss Requirements) in force since 1 July 2011. The circular divides bank assets into four categories - total assets, assets under management, so called privileged deposits, and required equity capital. The Swiss Finish adjusts the first and last of these.
The current version of the Swiss CAO includes three types of capital. Tier-1 is sub-divided into core capital and innovative core capital, tier-2 into upper and lower ‘floors', and tier-3 includes other forms of qualifying additional capital. This will be adjusted under the new, enhanced version ‘post Basel III' with the intention of improving the quality of regulatory capital, in part by reducing the sub-divisions in the previous tiers.
A key adjustment is to define core capital as including only CET1 and additional tier-1 (ADT1). CET1 capital will include paid-in capital, disclosed reserves, provisions for general banking risks, earnings carried forward, and earnings after the deduction of the expected proportion of CET1 capital to be distributed. Share capital held as preference shares, with or without votes, will not be eligible as CET1 capital.
Elsewhere, the concept of subordination in the case of bank liquidation is superseded by that of loss absorption. The new regulations differentiate between loss absorption in a going concern and loss absorption in a bank becoming insolvent. In a going concern, debt held as AT1 capital will accept a share of losses but only when CET1 capital has fallen below 5.125% of the relevant bank's total capital. Where insolvency is imminent, the same rules apply but extend to include tier-2 capital. Loss absorption is triggered before the bank becomes eligible for government aid or if FINMA decides it should take place.
In autumn 2011, the Swiss parliament approved the creation of capital instruments available to all domestic banks. The most important of these are so called write-off bonds which will become eligible for use as a form of regulatory capital and may be issued by banks if they choose to do so. Banks will also find it easier to raise new reserve capital subject to shareholder approval. Reserve capital can be created by a shareholders meeting amending the articles of association and thereby enabling a bank's board of directors to raise capital quickly. New shares can be issued at a discount to their market value, provided that this discount facilitates rapid placement. Banks can therefore re-structure their share capital with optimal flexibility and rapidity.
The Swiss are also introducing new regulations for domestic banks deemed to be of systemic importance. Last December, draft regulations additional to the Banking Act were released which require banks of systemic importance to hold CET1 capital of 4.5% of risk-weighted capital but also an additional equity capital buffer of 8.5% of risk-weighted assets. If the equity capital to be held as an equity capital buffer falls below this threshold for even a short period the bank must demonstrate what remedial measures it will take to recover the threshold.
The equity capital buffer can consist of CET1 capital or, with a limit of 3% of risk-weighted capital, of convertible capital with a conversion or a write-off trigger at 7% of total eligible CET1 capital. However, in addition to this requirement, banks deemed to be of systemic importance may be required to hold additional capital by FINMA. FINMA will review this on a quarterly basis. The required amount of this additional component will depend on various factors such as whether that bank may be re-structured or face possible liquidation.
How will the ‘Swiss finish' compare with the UK post-Vickers and the other EU member states? In truth, Switzerland and London have always competed in attracting capital. The Swiss Finish and post-Vickers environments may be broadly similar in terms of risk. But the Swiss are not proposing to split their banks up. Europe, by contrast, may have to wait some time for the Barnier reforms to take final shape and be implemented. The timing of reform will be an advantage to Swiss banks in attracting risk-averse clients.
There are over 200 banks of various sizes and types domiciled in Switzerland. Taking and investing other people's money is the country's most important industry; there are few public denunciations of ‘casino banking' by Swiss politicians. The ‘Swiss finish' is intended to render the country's banking and financial services industry devoid, as far as possible, of systemic risk.