UBS AG and Credit Suisse Group AG, the largest Swiss banks, were told to increase their ratios of capital to total assets as regulators increasingly question lenders’ internal models for assigning risk.
The banks should “consistently and fully implement their published plans on strategy and capital-building in order to further strengthen their resilience and, in particular, improve their leverage ratios,” the Swiss National Bank said in its annual financial stability report today. “By the end of 2014, Credit Suisse and UBS are likely to have already met the risk-weighted regulatory requirements applicable from 2019 and to substantially increase their leverage ratios.”
International regulators are increasingly looking at leverage, in addition to capital measures based on risk weightings assigned to different assets, to gauge banks’ financial strength. Their focus intensified as some banks improved capital ratios following the financial crisis by altering internal models or cutting risk-weighted assets without correspondingly shrinking their balance sheets.
Bank of England Governor Mervyn King said in a speech last night in London that leverage at U.K. banks remains too high. This week, Denmark’s financial watchdog told Danske Bank A/S, the country’s largest lender, to adjust its internal models in a step that will force the bank to add about 100 billion kroner ($17.8 billion), or 13 percent, to its risk-weighted assets.
UBS declined 1 percent to 16.45 Swiss francs by 9:33 a.m. in Zurich trading, reducing the gain this year to 15 percent. Credit Suisse fell 2 percent to 25.92 francs, trimming its advance in 2013 to 19 percent.
Officials at both banks declined to comment on the report.
The ratio of loss-absorbing capital to total on and off-balance-sheet assets at both Swiss banks was 2.3 percent at the end of March, the SNB said. This ratio will have to rise to at least 3.1 percent by 2019 under the provisions of the Swiss too-big-to-fail rules.
“Given the prevailing risks in the environment and the losses incurred in the recent financial market crisis, the SNB still considers current leverage ratios at the Swiss big banks to be low,” it said. “This indicator is growing in importance as a measure of banks’ resilience.”
The banks need to increase transparency with regard to their risks and the models they use to evaluate such risks as the credibility of internal methods, as opposed to the use of standardized risk weights prescribed by regulators for specific asset classes, is increasingly being called into question, the central bank said.
“Understanding individual banks’ models, and comparing models between banks, is very difficult,” the SNB said. “Different internal model assumptions can result in different capital requirements for two banks with a similar asset structure. It cannot be ruled out that models might tend to underestimate the risks.”
A study by the Basel Committee on Banking Supervision published earlier this year of how banks use internal models to evaluate market risks found “considerable variation” between lenders. The study asked 15 internationally active banks with significant trading assets to calculate market-risk metrics on a hypothetical diversified portfolio using their internal models and found the highest implied capital requirement for that portfolio based on the different levels of risks the banks assigned to it to be 2.5 times the lowest.
The SNB recommended that UBS and Credit Suisse calculate and disclose their risk-weighted assets according to both their internal models and the standardized approach to improve transparency as well as publish the reasons behind any changes in risk-weighted assets over a period. The banks should also publish a quantitative assessment of their total risk, the central bank said.
The SNB’s financial stability report last year sent Credit Suisse shares down 10 percent in one day after the central bank urged a “marked increase” in its capital before the end of 2012. That report also recommended that UBS continue with its policy of dividend restraint to build up capital.
Credit Suisse in July 2012 announced plans to increase capital by 15.3 billion Swiss francs ($16.5 billion) through measures including the sale of mandatory convertible securities, properties and units. The bank’s common equity ratio under fully applied Basel III rules rose to 8.6 percent at the end of March from 4.4 percent a year earlier.
UBS’s common equity ratio under fully applied Basel III rules rose to 10.1 percent by the end of March from about 7.5 percent a year earlier.