What Do the New 'Too Big to Fail' Rules Mean for Swiss Banks?
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What Do the New 'Too Big to Fail' Rules Mean for Swiss Banks?

The Swiss government has adjusted the 'too-big-to-fail' (TBTF) rules, including a new leverage standard. How will these changes affect banks?

At the end of October, the government announced stricter capital rules for the two 'globally systemically important Swiss banks' (G-SIBs) – Credit Suisse and UBS. They will be expected to meet a 5 percent tier 1 (T1) leverage ratio by the end of 2019.

Of this, 3.5 percent has to be met with common equity tier 1 (CET1) capital and 1.5 percent with high-trigger additional tier 1 (AT1) capital.

The capital requirements for the other systemically important Swiss banks considered TBTF – Zuercher Kantonalbank, PostFinance and Raiffeisen – will also increase.

Apart from the basic requirement, most details for these three banks will only be finalized over the next two years.

Capital requirements for Swiss G-SIBs

Capital requirements for Swiss G-SIBs

Source: FINMA, Credit Suisse

New Leverage Ratio and Risk-Based Capital Requirements

  • Leverage ratio: 5 percent minimum for the two Swiss G-SIBs – 3.5 percent can be met with CET1 capital and 1.5 percent with high trigger AT1 instruments. This compares to 3.1 percent under the old regime, see Figure 1. The basic requirement for the other systemically important banks is 4.5 percent plus a progressive component.
  • Risk-based capital: Total going concern capital is set at 14.3 percent, of which 10.0 percent has to be met with CET1 capital and 4.3 percent with high trigger AT1 instruments (vs. 10 percent CET1 and 3 percent AT1 previously).

    Additionally, 14.3 percent of the gone concern capital requirement has been introduced for the two Swiss G-SIBs, leading to a total risk-based capital or the so-called 'total loss absorbing capacity' (TLAC) of 28.6 percent of risk-weighted assets or 10 percent in terms of leverage exposure, see Figure 1. However, a discount of up to 2 percent (5.7 percent) of leverage exposure (risk-weighted assets) is possible, subject to better resolvability and size.

Swiss Leverage Rules: Stricter than Europe, in Line with US

The current leverage standard defined by the Basel Committee requires a minimum 3 percent T1 leverage ratio. As many banks already report levels that are meaningfully above 3 percent, the informal European target applied by the market is, in our view, closer to around 4 percent.

Required leverage ratios are higher in the US than in Europe. Large US banks need to conform with a leverage ratio of 5 percent (bank level) to 6 percent (holding company level). These numbers appear comparable with the Swiss rules.

However, US and Swiss banks clearly differ in terms of balance-sheet structure, with the securitization of mortgages and netting of derivatives representing standard features in the USA, in contrast to Switzerland.

US G-SIBs will have to hold 16.5 percent of risk weighted assets for Bank of New York to a maximum of 22.5 percent for Citigroup, while Morgan Stanley, Goldman Sachs and Bank of America are at 22 percent of TLAC capital – meaningful below the Swiss standards of 28.6 percent.

We believe the Swiss rules on TLAC are stricter than the regulations in other jurisdictions. The British banking regulator, for example, stipulates a TLAC leverage requirement of 6.5 percent and a TLAC gone concern capital requirement of 18 percent. The UK regulator thus remains materially below the Swiss rules of 10 percent and 28.6 percent respectively.

Credit Concerns (Pending Holding Company Issuance and Regulatory Par Calls)

Two major concerns may arise following the newly announced TBTF rules:

1. The potential supply of TLAC conform senior unsecured debt (out of the holding company) could put pressure on existing senior unsecured debt spreads, although this is mitigated by the 4-year phase-in period and broad market access of the two G-SIBs.

2. The change in regulation could open the door for regulatory par calls of outstanding T1 and T2 instruments that do not comply with the new settings. Given the current historical low interest rate environment and the wish to conform to the new regulations, banks could be tempted to execute the regulatory calls. However, according to the Swiss Financial Market Supervisory Authority (FINMA) factsheet from 21 October, the government also announced comprehensive 'grandfathering' provisions for instruments issued under the old TBTF regime, saying securities will be "grandfathered until they expire or are callable."