UBS AG and Credit Suisse Group AG (CSGN) need to hold almost double the capital required under Basel III rules, said a Swiss government-appointed panel, proposing the first capital surcharge on too-big-to-fail banks.
Switzerland’s biggest banks should hold total capital equal to at least 19 percent of their assets, weighted according to risk, compared with 10.5 percent level the Basel Committee on Banking Supervision announced last month, the Swiss panel said today. By 2019, the lenders need to have a common equity ratio of at least 10 percent, compared with 7 percent required under Basel III rules, and the rest in contingent capital.
Switzerland, which propped up UBS in the credit crisis, asked the panel of bankers, regulators and other experts to propose ways of avoiding future bailouts. The two banks’ total assets of 2.6 trillion Swiss francs ($2.64 trillion) are more than four times the size of the Swiss economy.
The plan is “a win-win situation for Switzerland,” said Harris Dellas, a professor of macroeconomics and monetary policy at the University of Bern. “If the banks don’t manage to raise the required extra capital, they will have to shrink without the government directly forcing them to. If they do, then this means that the markets have faith in them and they can continue playing in the big league.”
No Share Sales
The proposals, which have to be endorsed by the government and approved by Parliament, may jump-start the market for contingent convertible bonds, or CoCos. The banks, which said last week their risk-weighted assets may balloon to 400 billion francs each under the Basel III rules, may have to sell as much as 72 billion francs in CoCos to meet the new requirements, according to Bloomberg calculations. The banks said they plan to take steps to “significantly” reduce risk-weighted assets.
“It’s obviously a challenge to the Swiss banks to have a massive overcapitalization relative to peers, but it is achievable,” Dirk Hoffmann-Becking, a London-based analyst at Sanford C. Bernstein, said. He said the minimum common equity requirement is lower than the 12 percent he expected.
UBS fell 0.5 percent to 16.58 francs in Zurich trading, paring this year’s gain to 3.3 percent. Smaller rival Credit Suisse climbed 0.4 percent to 41.94 francs.
UBS is “confident” of being able to meet the new requirements without raising common equity or disposing of any “material” part of the business, Chief Financial Officer John Cryan said on a conference call. While UBS still sees the right level of capital for its business at about 50 billion francs, meaning a common equity ratio of about 13 percent, the bank may resume dividend payments before it hits that mark, he said.
Credit Suisse said it can comply with the measures “without having to materially change its growth plans or current capital and dividend policies.”
Dividend payments in the coming years will depend on whether the banks are successful in selling contingent convertibles, Hoffmann-Becking said. Even if they can’t sell any CoCos and have to meet the 19 percent target with only common equity, UBS could achieve that in 2014 and Credit Suisse in 2015 to 2017 by cutting risk-weighted assets and halting dividends.
“There is a big interest in having a functioning CoCo market,” Thomas Jordan, vice chairman of the Swiss central bank and a member of the panel, said at a press conference in Bern. The cost of CoCos may be between those of equity and of corporate bonds, with the added advantage of interest payments being tax deductible, he said. “CoCos would provide capital exactly at the time when it’s needed,” he said.
The panel, which rejected proposals to break up the two Zurich-based banks or directly limit their size and activities, such as proprietary trading, recommended a “rapid” implementation of all the proposals as a package. Peter Siegenthaler, who heads the commission, said he would expect the government to send the proposal to Parliament next year.
Three of the four biggest parties in Switzerland’s parliament signaled they may approve the commission’s proposals.
“This is a good proposal with the right priorities,” said Hans Kaufmann, the economic affairs spokesman for the Swiss People’s Party. We are “very satisfied” with the report, said Fulvio Pelli, president of the Swiss Liberals. The CoCo bonds are a “good idea,” said Pirmin Bischof, a member of the lower house for the Christian Democrats.
The minimum equity proposals were watered down by representatives of the big banks while measures to curb risk-taking are insufficient, the Social Democrats said.
The Basel committee on Sept. 12 set the new minimum ratio of common equity to risk-weighted assets for banks from 27 countries at 4.5 percent, plus a buffer of 2.5 percent. The requirement, which has to be met by 2019, compares with the 2 percent minimum ratio under less-strict Basel II rules.
Under today’s proposals, the two banks may need to increase the capital buffer to 8.5 percent. Of that, at least 5.5 percent has to be in the form of common equity, compared with Basel’s 2.5 percent, and the rest can be made up of contingent capital, such as CoCos.
The plan is also the first globally to apply a specific capital surcharge for systemically important banks. The size of this additional capital buffer, currently proposed at 6 percent, can change over time, depending on the ratio of a bank’s assets to the Swiss economy, its market share of domestic lending and how easy it would be to liquidate. All of this cushion should be in the form of contingent capital, the panel said.
The first contingent capital buffer should convert into equity once common equity falls below 7 percent of risk-weighted assets. The second cushion could convert at a 5 percent common equity ratio and may be used to support the systemically important parts of a bank’s business, while the rest is wound down in a crisis, the panel proposed. The experts also suggested making stricter liquidity rules for the two banks, which came into force at the end of June, into law.
UBS’s Cryan said he doubts the bank would let common equity fall as low as 5 percent, triggering the conversion of CoCo bonds, which would make the second buffer a “very expensive insurance policy.” He said he wasn’t sure which investors would buy the instruments, as equity holders would prefer stocks and traditional fixed-income buyers would demand a “significant premium” for the additional risk.
Switzerland rescued UBS in 2008, investing 6 billion francs to help the bank spin off $39 billion of toxic assets into a Swiss central bank fund. The state sold its UBS holdings for a profit of 1.2 billion francs less than a year later. Credit Suisse declined government assistance.
Switzerland is not alone in addressing the issues of too-big-to-fail banks. The Financial Stability Board, which coordinates the work of national financial regulators on an international level, is due to make recommendations on the topic to the Group of 20 leaders’ summit in November.
The U.S. passed a set of financial rules in July, giving regulators new authority to unwind failing financial firms that may threaten the entire system, as well as imposing limits on proprietary trading at banks. The bill, known as the Dodd-Frank Act, also prevents the Federal Reserve from approving bank acquisitions that would result in a firm exceeding 10 percent of the total liabilities of the U.S. banking system and requires regulators to make recommendations on standards for risk-based capital, leverage, liquidity and contingent capital.
At the height of the credit crunch in 2008, Swiss regulators gave UBS and Credit Suisse four years to raise their risk-weighted capital to as much as double the Basel II requirements. A cap on leverage means the banks must aim to hold capital equal to at least 5 percent of their assets in good times.
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