Swiss banks ask, how about a magic trick?

Banks pull off an accounting trick – with the help of their regulator

What if there was a way for a bank to conjure higher net interest income (NII), without raising rates for loans or cutting them for deposits? What if it could do so with just a flick of an accountant’s pen? 

You would be wise to be sceptical, as Gotham City’s thugs were when Heath Ledger’s Joker asked: “How about a magic trick?” 

But in this context, there’s no need for any Hollywood special effects, nor a psychopathic clown. Just enterprising bank managers and a willing financial regulator. 

Two banks have already pulled off the trick: UBS and Credit Suisse. 

On October 1, 2018, UBS began reporting in US dollars, instead of Swiss francs and UK pounds.

This resulted in an immediate uplift in group reported NII – of $300 million annually. Abracadabra! The bank also benefited from reduced foreign exchange-induced earnings volatility, even though a hefty chunk of its assets and liabilities are denominated in currencies other than the dollar.

This October, Credit Suisse emulated its Swiss peer by pulling off a similar currency switcheroo for its operational risk-weighted assets. As of the end of the fourth quarter, these would be denominated in dollars instead of Swiss francs.

The bank said the move was justified as the majority of its historic op risk losses (read ‘fines’) were incurred in US dollars. But it also meant the bank would hold more capital in dollars than francs, which, given the interest rate differential between the two currencies, and the effects of changing its capital hedging programme, will yield Sfr60 million ($60.2 million) of additional NII in Q4. The total benefit on a full-year basis is expected to be $250 million.

Neither bank could have pulled off the feat without their glamorous assistant, Finma. The Swiss watchdog signed off on both changes.

How can a change in reporting currencies lead to millions in additional earnings? It sounds like sleight-of-hand. Certainly some magical thinking is involved. In Credit Suisse’s case, by choosing to denominate op RWAs in dollars, it has to hedge the equity capital held against these by investing in dollar assets – which offer a tastier pick-up than Swiss franc investments. Essentially, it gave itself permission to invest more in higher-yielding assets. 

Seeing through the illusions woven by financial reports is part and parcel of being an investor and, in these cases, shareholders have agreed to accept the changes as legitimate, rather than a case of accounting trickery.