Monetary and financial issues

Economic Survey of Switzerland 2009: Containing the systemic risks from exceptionally large financial institutions

 

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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Switzerland published on 15 January 2010.

 

Contents

 

Swift action has ensured stability of financial intermediaries, but supervision, especially of the large banks, needs to be strengthened further

Since the outbreak of financial market turmoil, asset write-downs in particular of the biggest Swiss bank relative to its capital base have been larger than of most of its peers surviving the crisis in the US or among EU countries. Nonetheless, negative consequences for the Swiss financial system have been contained. In part, this reflects the provision of ample liquidity by the SNB. The early decision to transfer toxic assets from UBS to a dedicated fund helped to partially restore confidence. Moreover, the domestically oriented smaller banks have been little affected by the crisis. However, there is a particular need for Switzerland to limit the probability of failure of a large intermediary.


The Swiss financial market regulator (FINMA) was one the first to address weaknesses in the supervision of systemically important banks revealed by the global financial crisis. First, guidelines have been issued on compensation for bank and insurance staff to mitigate incentives for excessive risk-taking. Second, the two largest banks will need to maintain minimum risk-weighted capital adequacy requirements (CAR) of at least 50% above the standard defined by the Swiss implementation of the minimum set by the Bank of International Settlements (BIS) from 2013 onwards. Third, this ratio will be increased to two times the standard when the bank’s profits are high. Fourth, the large banks will be subject to a minimum capital requirement of 4% of total assets (“leverage ratio”) for individual units and of 3% at the group level from 2013. This leverage ratio includes all assets acquired in investment banking although domestic loans are to be excluded.


Leverage and capital adequacy ratios of major international banks¹
Per cent
 


1. Banks' acronyms are the following: BA, Bank of America Corp.; BB, Barclays Bank; BNP, BNP Paribas; CA, Crédit Agricole Group; CCB, China Construction Bank; CITI, Citigroup; CSG, Credit Suisse Group; DB, Deutsche Bank; HBO, HBOS; HSBC, HSBC holdings; ICBC; ING, Ing Bank; JPM, JP Morgan Chase and Co.; MS, Mitsubishi UFJ Financial Group; MZ, Mizuho Financial Group; RBS, Royal Bank of Scotland; SCH, Santander Central Hispano; SG, Société Générale; SM, Sumitomo Mitsui Financial Group; UBS; UNI, Unicredit; WF, Wells Fargo and Co.

Source: Banker Magazine; Euromoney.


However, the specified lower minimum for the CAR and the specified group-level minimum for the leverage ratio are below the ratios currently maintained by a significant number of international banks, including the two large Swiss banks. A definition of a cyclical criterion based on market rather than individual bank performance would more effectively counteract the tendency for excessive risk-taking when credit markets are buoyant and avoid imposing lower capital costs on weakly performing banks. In view of the particular risks stemming from any potential large bank failure in the Swiss context, it should be ensured that  capital adequacy and leverage ratios for the two big banks are set such that they are close to the highest actually observed ratios of major international banks. Given current circumstances this would imply keeping capital adequacy ratios to at least 150% of the current BIS minimum in the near-term and raising them to twice that level once the banks’ financial strength has been restored as well as a leverage ratio of at least 4% at the group level. Decisions will also need to adapt to emerging international supervisory standards. The rule-based mechanism mandating cyclical capital buffers that rise during market expansions should be based on indicators of the market cycle and risks, rather than on bank profitability. Domestic lending should be included in its calculation.


The share of assets and liabilities held in foreign currency is large. Owing to the mismatch of maturities between assets and liabilities, a liquidity shortage in foreign currency could trigger a run by creditors and potentially a currency crisis, although banks have access to liquidity facilities of foreign central banks. Hence, liquidity regulation and oversight of the largest institutions needs to be given high priority and should be extended to other financial institutions over time. The authorities are considering specific foreign currency liquidity requirements imposed on banks. Consideration should be given to specifying a minimum ratio of liabilities likely to be the most stable relative to foreign currency denominated assets as part of the liquidity regulation. Deposit insurance is currently unfunded and therefore particularly vulnerable to requiring public funds when a systemic crisis occurs. Partial funding of the deposit insurance system should be instituted. The present ceiling on insured deposits should be revised if necessary to keep in line with further changes in other countries. The government has submitted a reform of deposit insurance to public consultation, foreseeing partial funding and risk-weighted contribution rates.


The capabilities of the supervisor are improving but need to be further bolstered…

FINMA enjoys a degree of independence from government broadly similar to that of peers in other OECD countries and the powers assigned to it follow international best practice. Nonetheless, ensuring the financial supervisor’s freedom is a particular challenge for a small country with an important financial services industry and cannot be assured through formal institutional arrangements alone. FINMA’s staff resources appear relatively limited in view of the size of the intermediaries it regulates and significant recourse is taken to external auditors primarily on the banking side. FINMA’s personnel and other resources should continue to be reviewed to determine if they are adequate. In particular, compensation policies should be sufficiently flexible to attract and retain highly-skilled staff. Consideration should be given to widening the range of authorized external auditors and to regularly rotating those responsible for particular institutions, as a means to sustain the objectivity of the oversight process.


…with a stronger implication of the SNB in macro-prudential regulation and institutionalized international cooperation

Weaknesses in supervisory frameworks identified in OECD countries include inadequate monitoring and assessment of systemic risks and limited ability to oversee the cross-border activities of large complex institutions. In Switzerland, besides FINMA, the SNB is responsible for monitoring developments in the banking system as a whole while current arrangements provide for the exchange of information and co-ordination on related risks between the SNB and FINMA. The large insurance and pension fund intermediaries are not included in the current arrangement of macro-prudential oversight. Macro-prudential oversight needs to be broadened to include monitoring of all the major components of the financial system, including pension funds and insurance. In conformity with its legal mandate to contribute to financial sector stability, the SNB should lead, together with FINMA, which should remain the enacting body, the elaboration of macro-prudential standards and make its views public.


Stronger cross-border arrangements with financial authorities in other countries are essential to ensuring effective supervision of the largest Swiss financial institutions. Internationally-coordinated contingency plans to unwind failing multinational intermediaries orderly, limiting the need for bail-outs, would be particularly important for Switzerland. Steps should be taken to further develop the colleges of supervisors for each of the two largest banks to coordinate as well as develop common contingency plans for future crises.


In March 2009 the Swiss government endorsed the OECD standard of transparency and exchange of information in tax matters, which creates an obligation to exchange information, including banking information that is foreseeably relevant to the correct enforcement of partner countries’ tax laws. Since then, the Swiss government has removed its reservation to Article 26 of the OECD Model Tax Convention, has already revised its tax treaties with several OECD countries in the course of 2009 and is negotiating with several others. One or more of these treaties may be subjected to approval by referendum. The OECD welcomes this important policy change and encourages Switzerland to continue to implement this decision as rapidly as possible.


 

How to obtain this publication

 

The complete edition of the Economic Survey of Switzerland is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations. 

 

Additional information

For further information please contact the Switzerland Desk at the OECD Economics Department at eco.survey@oecd.org.

The OECD Secretariat’s draft report was prepared by Andrés Fuentes, Charles Pigott and Eduardo Camero under the supervision of Pierre Beynet. Statistical assistance was provided by Patrizio Sicari. The survey also benefited from external consultancy work.

 

 

 

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