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UBS, Credit Suisse Must Boost ‘Thin’ Capital Buffers, SNB Says

UBS AG and Credit Suisse Group AG, Switzerland’s biggest banks, should bolster their capital buffers as soon as possible to guard against the risk of a deteriorating economy, the Swiss central bank said.

“The big banks should build up an adequate base of loss-absorbing capital as swiftly as possible,” the Swiss National Bank said in its 2011 Financial Stability Report published today on its website. “Risks in the economic environment remain considerable and, in relation to past losses, the big banks’ loss-absorbing capital buffers are still thin.”

Global regulators are working on stricter rules to curb risk-taking by banks and avoid a repeat of the 2008 failure of Lehman Brothers Holdings Inc. that threatened to derail the world economy. Switzerland’s Parliament is debating government proposals that require Credit Suisse and UBS to build up capital in line with Basel III rules.

While UBS didn’t pay dividends for 2010 and Credit Suisse sold $2 billion of so-called contingent convertible bonds in February, the SNB said both banks must take further steps to boost capital.

“The leverage of Switzerland’s two big banks remains high, leaving correspondingly little margin for error in the assessment of risk,” the SNB said in the report.

Without the “assumption of an implicit state guarantee,” Moody’s Investors Service’s long-term credit rating for UBS would be three steps lower, the central bank said. Credit Suisse’s rating would drop two steps, it said.

‘Potential Contagion’

The Swiss government has proposed requiring Credit Suisse and larger rival UBS to hold capital equal to at least 19 percent of their assets, weighted according to risk. The banks can use CoCos, which automatically become equity when capital falls below preset levels, to satisfy almost half that requirement.

The central bank highlighted the threat of Europe’s debt crisis affecting Switzerland’s two biggest banks.

“Credit and market risk, amplified by potential contagion effects from the sovereign debt crisis in the peripheral euro area, would constitute the most important source of risk for these banks under the adverse scenario,” the SNB said. “The potential losses under this scenario would be substantial.”

While conditions for the Swiss banking industry have improved in the past year, the SNB cautioned against a real-estate bubble that would put the country’s cantonal and Raiffeisen banks at particular risk.

‘Signs of Overheating’

“Over the past years, the growth rate of Swiss real estate prices has been higher than fundamentals would justify,” the central bank said. “At the regional level, there are already clear signs of overheating.”

Swiss interest rates, the lowest among major global economies after Japan and the U.S., are fueling housing demand. Over the past two years, real prices for single-family houses rose by 8 percent and those for owner-occupied apartments by 10 percent, according to the report. Mortgage lending by domestically focused banks climbed 6.1 percent in 2010, higher than the long-term average, the SNB said.

“Developments in the real estate and mortgage markets could represent a considerable credit risk and pose a potential threat to financial stability in the medium term,” the central bank said.

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