Q&A: Finma’s Branson on Swiss banks and the Swiss franc

CS and UBS have "reshaped and resized", but risk to Swiss economy needs to be cut further

Mark Branson, Finma (photo, Keystone)

Borrowing the terms of Aesop's well-known fable, Switzerland's post-crisis capital reforms were the hare to the rest of the world's tortoise. The country quickly agreed tougher capital standards than those advocated in Basel III and brought them into force earlier – the so-called ‘Swiss finish'.

But it turns out the Swiss may not be finished. While the hare raced past the line set by international regulators, then paused to catch its breath, the tortoise kept plodding steadily on, and now has a healthy lead in some respects.

Or an unhealthy one. A committee of experts convened by the Swiss government concluded last December that Switzerland needs to boost both risk-based and leverage capital requirements for its regime to remain among the world's most conservative.

"When we looked at the calibration, and especially at the leverage requirements in Switzerland in light of international standards and what is a sensible loss-absorbing capacity for banks of that size, we concluded there is certainly room for more. And yes, we think banks can cope with those extra requirements," says Mark Branson, chief executive of Swiss prudential regulator Finma.

The leverage ratio is the obvious item on the to-do list. In 2010, the Basel Committee on Banking Supervision said it would test a minimum of 3% – a placeholder, Branson says – but put off firmer definition of the methodology and also set an implementation date of 2018. Since then, regulatory concerns about the robustness of risk-weighted capital have intensified, and a number of jurisdictions have either gone beyond the Basel III minimum, or are planning to. In the US, large bank holding companies will need to meet a 5% level.

The size of the mismatch between the risk in the banking sector and the size of the Swiss economy has reduced. However, we, along with the SNB and the government, feel there is more that can be done

Branson insists Basel has not set a formal minimum yet, and says Switzerland will talk to other jurisdictions before arriving at its own requirement.

But the too-big-to-fail concept is not only a banking issue. Insurance companies, in particular, have been on the regulators' radar since the US government bailed out American International Group in September 2008.

The major issue for regulators in different jurisdictions is now to reach consensus on which insurers and reinsurers should be recognised as global systemically important institutions (G-Siis). This is proving difficult. As Risk.net revealed last month, the Bank of England privately challenged the omission of Berkshire Hathaway from a provisional list of US G-Siis, and Branson concedes international agreement is some way off.

On the similarly vexed question of whether to designate asset managers as systemically important, Branson adds it is important not to draw up these lists until a viable resolution framework is in place – without it, the assumption might be that the wearer of a too-big-to-fail badge would be in line for state support if it flies into a storm.

In this interview with Risk.net, Branson also discusses the decision by the Swiss National Bank (SNB) to end its defence of the franc on January 15, which caught the market by surprise – and, it seems, Finma as well.

He also touches on proposals for banks to bolster their minimum equity capital levels with a buffer of bail-inable debt – the total loss-absorbing capacity (TLAC) framework.

Did the SNB discuss its decision with you in advance?

Mark Branson: No, it would never discuss its monetary policy decisions with us and nor should it.

But it wasn't just a monetary policy decision – it had market and financial stability implications; some banks incurred significant losses.

MB: It was a big step, but it was taken as part of the monetary policy competencies of the SNB, and it would not be something for us to comment on.

What we've seen over the period since the removal of the floor is an ability for banks to trade in the Swiss franc as an independent currency, which has actually had – both immediately and thereafter – not only negative effects on trading revenues but also positive effects. So I don't think you can draw exactly the conclusion you're hinting at in terms of trading positions, which are clearly not all in the same direction. While some banks may have lost immediately after the floor was removed, others undoubtedly gained.

Finma required UBS to automate at least 95% of its forex trading as part of its punishment for rigging the fix. Following the Swiss franc announcement, the bank switched off its e-trading engine for 10 minutes because it feared the system would not provide the right prices. Did the push to automate trading introduce new risks?

MB: I don't think so. And I don't think the two issues have anything to do with one another. It's clear there were some disruptions in liquidity in that particular market for a short period of time after the event. That is because the event was highly unexpected and obviously produced a great deal of uncertainty until the price discovery mechanisms in the market were able to function again. In that kind of situation, you have challenges in the price discovery process as people react to an unexpected piece of news, and you can also have operational challenges given the high volumes traded. Here, I think you had both of those, which were resolved in a relatively short period of time.

So, I don't think it had anything to do with the proportion of trading the banks were conducting electronically or not electronically.

So you're not having second thoughts about telling UBS to automate its forex trading?

MB: Absolutely not, and we have never said 100% automation. We said 95% automation, which is easily achievable in the foreign exchange markets.

mark-branson-1-appWe had seen manipulation of forex markets by voice traders that went way beyond the bounds of what was legal and acceptable. An unnecessarily high proportion of foreign exchange trading running outside the automated systems was a contributing factor, and we have narrowed down that possibility in that particular bank.

Some buy-side participants have called for an inquest into the events of that day, and the subsequent loss of liquidity. Is that something you are considering?

MB: What we saw on that day was a certain amount of short-term market and operational disruption. Where we have concerns around that, we have addressed institutions individually to understand how they reacted over the course of that day.

So there are no plans for a broader inquest?

MB: Correct.

Following the crisis, Switzerland moved quickly to implement new prudential reforms. Do you think the risk the big Swiss banks pose to the domestic economy is now acceptable?

MB: We have come a long way since the days when the largest Swiss bank had a $2.5 trillion balance sheet and was running a risk that they themselves didn't well understand. The banks have reshaped and resized, therefore the size of the mismatch between the risk in the banking sector and the size of the Swiss economy has reduced. However, we, along with the SNB and the government, feel more can be done to reduce the residual risk we still have with the large banking industry and two particularly large banks in a relatively small economy.

We've come a long way, we have achieved a lot, but there is still work to be done in terms of prudential buffers, particularly in terms of resolvability.

In December, a commission of experts led by professor Aymo Brunetti recommended Switzerland should increase both risk-weighted and leverage-based capital requirements for Credit Suisse and UBS, and noted the two banks have a leverage ratio of 3.12% on average – which is well below the minimum set in the US, for instance. Where do you think the minimum should be set?

MB: As you said, the government has agreed with the findings of the committee led by professor Brunetti, which concluded the capital standards should be revised so they are – in both risk-weighted and non-weighted terms – among the highest internationally. That gives you a range of where the leverage ratio could be set.

We are going to work with other authorities over the rest of this year to come up with the answer to your question, so you will have to watch this space to get detailed numbers.

I believe a new working group will be in charge of translating the committee's principles into a new legal framework. When will that happen?

MB: The proposals need to be developed over the course of this year, and not all of them require a change in the law - some can be changed at a lower level of the regulatory spectrum. So I'd expect a rolling implementation thereafter.

Will the large Swiss banks cope with higher capital requirements?

MB: There has been a global process of rethinking and recalibrating the capital requirements for the largest global banks. This is a response to the way some of those banks endangered the financial system in the financial crisis, and the work is still ongoing. When we looked at the calibration, and especially when we looked at the leverage requirements in Switzerland in light of international standards and what is a sensible loss-absorbing capacity for banks of that size, we concluded there is certainly room for more. And yes, we do think banks can cope with those extra requirements.

Do you understand why some jurisdictions might stick to the Basel III minimum leverage ratio of 3%?

MB: Basel has yet to opine on the minimum requirements. I think 3% was a preliminary idea of where it might be set.

I think you also have to differentiate between non-systemically relevant banks and those that are systemically relevant, either globally, or domestically, or both. There is an emerging consensus that for global systemically relevant banks (G-Sibs) you not only need higher risk-weighted requirements but also a strict leverage limit. If you look around, many jurisdictions that host G-Sibs are going in that direction.

Basel needs to decide where it would like to set that international minimum. And, clearly, the world has moved on since the 3% level was first put into the room.

On the resolution of banks, the Financial Stability Board released a consultation paper on TLAC last November, going beyond capital to include bail-inable debt. The requirements could be set between 16% and 20% of RWAs. Should there be a blanket minimum, or should national supervisors have some freedom to calibrate the requirement?

mark-branson-3-appMB: It would be best to set international minimum requirements and allow jurisdictions with specific issues to go above the minimum. Once you have set a range, you shouldn't disqualify the option to go over the top of that, but you should disqualify the option to go under it.

One concern is that as TLAC debt matures, a bank could end up breaching the requirement – triggering resolution – despite having a solid capital base. Is that an issue?

MB: I think the replenishment of TLAC when instruments mature is going to be a key part of the requirements in every jurisdiction, but the trigger for resolution will be a different one. The trigger in most jurisdictions is linked to the minimum prescribed quantity of hard equity capital.

One of the big questions about resolution is how it will work cross-border. In this context, what are the implications of the US requirement for foreign banks to set up local holding companies if they exceed a certain asset size?

MB: It means Swiss banks heavily active in the US will be establishing such a holding company in the US and will be subject to US regulation, which is an understandable development from the US perspective. Resolvability requirements push a more modular approach to the way global banks are organised and the way they allocate their capital and liquidity resources. That's a new fact of life in global banking.

Are you comfortable with that?

MB: Authorities rightly want to secure the stability of very important players within their own jurisdictions. You must also have a discussion about how the various types of loss-absorbing capacity are allocated between entities. How much do you want to hold as a reserve pool, if you like, at the top of the group? And how much needs to be pre-allocated into various subsidiaries?

What is very important is to make sure that when banks have a resolution strategy, which is driven from the top of the group through the so-called single-point-of-entry strategy, national developments don't undermine that. But I don't think that's the intent in the US.

Finma opted for single point of entry in 2013, which obviously has implications for the legal, capital and funding structure of the Swiss banks. How close are they to satisfying those requirements?

MB: Both banks strongly favoured the single-point-of-entry resolution strategy, but to make that plausible requires a certain amount of legal entity restructuring and changes in the funding structures of the groups. It's something we can't avoid if we want to reduce the too-big-to-fail problem over time, and I think both banks here have been heavily committed to that process. UBS has created a holding structure. Credit Suisse has started funding itself with bail-inable debt out of its holding company. So both are making key steps to subordinate bail-inable debt to the operating liabilities within their banks.

You have mentioned too-big-to-fail. In what non-bank sectors does Finma expect to regulate firms?

MB: There is some ongoing work at the international level to look at systemic risk in the insurance sector, but we have to remember insurance is completely different from banking. It's less interconnected and less susceptible to sudden withdrawals of clients. So one can't just copy and paste from one sector to the other.

When we looked domestically in Switzerland at the relevance of various sectors, we decided to concentrate on the banking sector and the financial infrastructures - the providers of payment, clearing and exchange services.

Will there be a G-Sii designation for Swiss Re?

MB: It's too early to say. A lot of work is still going on at the international level that relates to the designation of systemically relevant insurers or reinsurers.

How are those discussions progressing?

MB: I don't think it is easy, and that's because it's not easy to define where the systemic threat from insurance activities originates. Therefore, the exercise is proving difficult.

Could the work be concluded this year?

MB: I think the International Association of Insurance Supervisors is working very hard on the methodologies and would like to conclude this as soon as possible. It's not out of the question, but it's a complex topic. We don't currently have a full consensus and that will certainly take some time.

Could asset managers be systemically important as well?

MB: It's a difficult question to answer with certainty. A better question would be ‘can asset management activities be systemically relevant?'

Parallel to the insurance work, there is work going on internationally to look at that. We need to remind ourselves that when we declare institutions to be systemically relevant and too big to fail, we are creating an implicit expectation of state support in the absence of plausible resolution plans. So we shouldn't be creating those expectations where a resolution framework does not exist.

What kind of risks could asset management activities pose to the system?

MB: One of the questions that should be asked is about maturity transformation within asset management products. So when you have funds that are available short term – or promised to be available – but are invested in less-liquid products, then, if those less-liquid markets run into issues, do you have herd effects that could destabilise the market?

Money market funds, which were treated as a cash equivalent by their clients, had a certain destabilising role during the crisis. That's well-known and understood. But when you look further across the asset management spectrum, could you find any such forms of potential behaviour with systemic relevance?

On securitisation, do you expect the Basel Committee to modify its capital rules to reflect Europe's drive towards a two-tier market, with high-quality securitisations given a softer treatment?

MB: There is a lively discussion on the topic. Obviously, the idea is good, but the difficulty is to define what a high-quality securitisation is, knowing that low-quality securitisation wrecked the global financial system only a few years ago. Therefore, it's not an unimportant discussion. I don't think it was the intent of the global regulatory community to stop securitisation as a technique. The fact is that securitisation was wildly exaggerated in the build-up to the crisis and therefore, there is a lot of caution when one approaches the topic, and rightly so.

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