Are too big to fail banks too hard to control?

How bad is big for banks?

The debate about defusing the harmful effects of failing large banks took another turn this week with the Swiss financial regulator calling for new legislation.

This content was published on March 28, 2010 minutes

But regulating such large and complex institutions runs the risk of the rules themselves creating instability. Two national taskforces are currently weighing up how to solve the conundrum.

The catastrophic effects on the Swiss economy of UBS or Credit Suisse going bankrupt are obvious. The two largest banks inject a large share of the 15 per cent gross domestic product contribution from the financial sector.

They also employ tens of thousands of staff in Switzerland alone, while thousands of other jobs indirectly rely on these banks. In addition, they house vast quantities of assets from private clients and institutions, grease the wheels of countless businesses and contribute vast sums in tax revenues.

It is equally obvious that the taxpayer could not prevent a total collapse. UBS needed a SFr6 billion ($5.6 billion) capital injection two years ago to tide it over, but covering the total assets of either bank - each valued at several times that of Swiss GDP - would be beyond the powers of the state.

“Radical changes required”

The Swiss Financial Market Supervisory Authority (Finma) keeps a tight rein on the liquidity levels of both banks and the amount of capital reserves they set aside as a buffer. But Finma clearly stated this week that it needed help keeping the banks on the rails.

“If Switzerland is serious about tackling the problem of institutions being too big to fail, then radical changes are required,” said Finma chief executive Patrick Raaflaub. “ The [government] and parliament need to take responsibility for this.”

Although the speech was short on details, it did highlight the need for legislation on liquidity and capital requirements, and laws on how to wind down such large institutions. It also raised the spectre of breaking up big banks into smaller units by suggesting a “legal basis in relation to group structures”.

Such legal measures by the state would be too much to stomach, according to Nuno Fernandes, a professor of finance at the prestigious IMD business school in Lausanne.

“Government intervention would be very dangerous,” he told “Any legislation would result in additional capital requirements or taxes and that would translate into higher costs for customers. That would translate into higher mortgage rates.”

Furthermore, said Fernandes, there is an argument that size aids stability by diversifying revenue streams and increasing global reach. “Breaking up banks may actually increase systemic risk [to the economy as a whole],” he said.

Dire consequences

While neither big bank would comment on the Finma statement, Credit Suisse chief executive Brady Dougan warned in the Sonntag newspaper earlier this month that too many restrictions could squeeze the life out of banks.

“Regulation must make the financial system safer, but it should not make it inflexible and sluggish,” he said. “This would hamper economic growth and job creation.”

The Swiss Bankers Association (SBA) also warned against distorting international competition against Swiss banks by imposing rules that were more severe than other countries.

“The entry into force of regulations should be internationally coordinated and not attempted single-handedly by individual states,” SBA spokesman James Nason told

But the central financial authorities appear determined to stamp out the risk of a collapsing bank bringing down the whole economy. “No bank should be so systemically important that governments feel forced to rescue it from impending failure, fearing the economic costs such a failure would cause,” Thomas Jordan, vice-chairman of the Swiss National Bank, said in a speech this week.

Risk vs opportunity

Switzerland is anxious to preserve its status as a safe and reliable financial centre. And it is keen to avoid the catastrophic consequences of a large bank failing , such as Lehman Brothers in the United States and Iceland’s Kaupthing.

But Fernandes is convinced that that Switzerland has much to lose by applying government regulations that restrict the ability of institutions to compete against international rivals. He believes that it would be better to give more power to shareholders to decide on the future strategy of their banks than to pass down directives from the state.

Switzerland is not the only country contemplating a tougher legal framework for its financial sector. The US, Britain , France and the European Union are all debating proposals that would restrict the activities of financial institutions.

“Switzerland has a huge strategic opportunity to build itself up further as a leading financial centre,” Fernandes told “If the regulatory environment in other countries becomes more restrictive then Switzerland could benefit by attracting more business and more financial institutions away from these rivals.”

Matthew Allen,

Global financial regulations

Following the financial crisis, the collapse of Lehman Brothers and Kaupthing and massive state bail-outs of other institutions, several governments are considering tighter regulations to prevent such problems in future.

The US has led the way, with President Barack Obama proposing laws to reduce the risk of large banks failing and the possible impact on the economy if they do go bust.

One proposal recommended that financial institutions pay into a type of common insurance scheme that would substitute taxpayers’ money in the case of future bailouts.

A second plan – known as the Volcker Rules – is aimed at forcing banks that manage the normal accounts of the public to take fewer trading risks.

The Volcker regulations would ban such banks from trading their own assets on the markets (proprietary trading) or from having links with hedge funds and private equity firms.

Britain has also proposed a form of international bank tax to pay back taxpayers’ for bailing out banks. Britain and France have introduced one-off windfall taxes on large bonuses.

The global financial regulator – the Basel Committee on Banking Supervision – has also proposed measures to beef up the amount of capital banks must put aside for a rainy day.

Switzerland traditionally follows Basel rules with an extra “Swiss finish” to compel banks to hold more capital reserves than the regulations stipulate. In 2008 the forerunner to Finma significantly beefed up these requirements, particularly in the case of the two biggest banks, UBS and Credit Suisse.

In addition, Finma introduced binding guidelines from this year to curb excessive bonuses and link such remuneration to long-term targets rather than short-term goals.

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