As global financial regulators grapple with making the system safer, banks are trying to second guess the future landscape and formulate strategies to cope with it.This content was published on February 15, 2011 - 14:12
The main question for Switzerland’s biggest banks - Credit Suisse and UBS – is how much further will Swiss rules go in comparison to international standards, and how that might affect their ability to compete on a global scale.
Credit Suisse intimated last week that it has already reorganised enough to cope with any new demands. On Monday the bank announced that it had raised $6.1 billion (SFr5.9 billion) in extra funds from Qatar and Saudi Arabia to meet new capitalisation rules.
One of the first mass sale of so-called contingent convertible (coco) bonds by Credit Suisse represents a new means of stockpiling capital to firefight potential problems.
Cocos are the latest financial concoction designed to convert into shares if the bank's fortunes slump significantly.
Last week, UBS said the outlook was far from certain and that it would contemplate moving investment banking operations abroad if the “Swiss finish” proves too stringent.
“If the capital requirements in other countries are only half of those in Switzerland – and we think we have to stay in certain businesses – then we may have to operate them out of these countries,” said UBS chief executive Oswald Grübel.
The fear is that different countries will end up imposing separate regulations that fail to produce a level playing field for the larger banks. If that should happen, experts predict a bout of “regulatory arbitrage” as banks reposition themselves to avoid the most severe regimes.
Question of jurisdiction
Several theories have been put forward as to how banks could move risky assets around to avoid having to accumulate more risk buffering capital reserves than competitors.
These include moving liquid assets into funds, ring fencing poorly rated assets and entering into arrangements with hedge funds or so-called bridge banks to conduct riskier trades on their behalf.
The concept of removing risky operations from a banking group’s balance sheet by creating separate legal subsidiaries in other countries failed to impress the Swiss regulator – the Financial Market Supervisory Authority (Finma).
“As long as the risks of those operations could fall back on the parent company then it is clear that the capital rules of the home regulator would count,” spokesman Tobias Lux told swissinfo.ch.
One expert canvassed by swissinfo.ch cast doubt on whether Finma could extend its influence to foreign jurisdictions in such a case, but it is clear that regulatory arbitrage would enter new and uncertain territory.
Matthias Memminger, head of financial services advisory at PricewaterhouseCoopers Switzerland, believes banks would only undergo such drastic restructuring as a last resort.
“It is not impossible but it would be a big challenge to relocate businesses with a lot of regulatory and taxation uncertainty around it,” he told swissinfo.ch. “At the end of the day regulators want to be sure that client deposits will be safe and that there will be no risk spillover from other areas.”
“Banks will do what they can to avoid disruption to their business. They are structured the way they are for a reason, because it makes business sense,” he added.
The future regulatory landscape is still far from clear. Swiss proposals that would require the big banks to set aside nearly three times the global standard of capital reserves have yet to pass through parliament.
Time to exit risk?
In the meantime, the international regulatory authority is considering tighter rules for the largest banks and other countries may impose their own measures that close the gap with Switzerland.
But for some people in Switzerland, there is only one clear solution for Credit Suisse and UBS: to remove themselves from risky investment banking operations in the United States and other countries.
“The biggest mistake that the two big banks made in the past 25 years was not expanding into the broader wealth management arena, but in other risky and capital intensive businesses. It was like Roger Federer taking up football – it makes more sense to stick with what you are good at,” said Christian Raubach, a managing partner at Switzerland’s oldest private bank, Wegelin.
“Non-US banks are never going to succeed in investment banking in New York because they cannot attract the best talent. Proprietary trading and deal making is a zero sum game – the smarter person always wins,” he added.
Moving risk to another location would fail to address to real problem of reputational problems infecting core wealth management activities, according to Raubach. Wealthy clients have withdrawn more than SFr200 billion in assets from UBS since the financial crisis.
“Ring fencing risky operations in another regulatory regime is a non-starter because if those risks turn sour it could still jeopardise your reputation in private banking,” said Raubach.
“Who do you give your money to as a billionaire in Indonesia and Russia? The most important consideration is that the bank and country that you give your wealth to will be there tomorrow. You need a safe, reliable – and maybe even boring location.”
New regulatory landscape
The financial crisis of 2008 saw the collapse of US investment bank Lehman Brothers and the forced sale or government bailout of other institutions.
UBS became the worst hit bank in Europe, writing down more than SFr50 billion. It was forced to accept a Swiss government bailout and place its toxic assets in a central bank controlled fund.
The wave of banking failures prompted governments and financial regulators to work out a series of measures designed at making the financial system safer and to protect economies and ordinary depositors from the consequences of a repeat crisis.
Last year, the international regulator – the Basel Committee on banking Supervision – announced a series of measures known as Basel III.
Basel III dramatically raised the amount of core capital that banks must hold to cover risks to 7% in 2015, escalating to 8.5% by 2019.
Swiss proposals – that also include an extra provision for Credit Suisse and UBS – would demand a maximum of 19% capital reserves for the two big banks.
The Basel Committee is also formulating extra measures for “too big to fail” banks that could add an extra burden on larger institutions.End of insertion
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