The Swiss government's management of the failure of Credit Suisse in 2023 drew criticism from investors and banks alike. Just over a year later, on April 10, 2024, the Federal Council presented several proposals to strengthen the country's too-big-to-fail banking framework. Its report covers the main pain points highlighted by the Credit Suisse case.

The revised regulations aim to reduce the likelihood that a Swiss SIB will experience another crisis. The proposals would strengthen corporate governance, bank supervision, capital, and liquidity requirements. In addition, the introduction of crisis management tools should improve resolution planning and crisis cooperation among authorities.

In S&P Global Ratings' view, the main effect of the proposals would be to align Swiss bank regulations more closely with those in comparable jurisdictions, such as the EU and the U.K. That said, some of the revisions would mean tighter rules than those in other banking systems. Although the Swiss authorities recognize the need for global coordination and plan to advocate for changes at the Basel table, the Federal Council has signaled that it is determined to implement its proposals. Swiss rule-makers have more freedom than their EU neighbors to implement proposals at a national level, without coordinating policy initiatives across borders. They also benefit from the political momentum generated by the failure of Credit Suisse and its merger with UBS.

Most Swiss SIBs operate only in the domestic market. UBS is the only Swiss globally systemically important bank. Being subject to stricter rules than its global competitors could put UBS at a disadvantage in its foreign banking operations.

UBS Could Be Hit By Move To Limit Double Leverage

For international banking groups, the use of debt at the parent company level to finance equity participations in foreign subsidiaries (that is, double leverage) is a well-documented issue. The parent company, as a stand-alone entity, is itself subject to minimum capital requirements. If risk materializes at the subsidiary level, parent companies with excessive double leverage can quickly find their own capital position constrained. UBS is the only Swiss bank that has foreign subsidiaries.

Swiss regulations currently address double leverage via a scheduled increase in risk-weighting for such participations. However, the Federal Council has now floated the idea of simply deducting equity participations in foreign subsidiaries from the parent bank's capital. This implies full capitalization of the risks stemming from foreign subsidiaries, in compliance with the Basel III standards. However, it would not only mark a departure from the Swiss authorities' previous, gradual approach but also put Swiss rules at odds with those in the EU. The EU's "Danish compromise" allows for a preferential capital treatment of financial subsidiaries.

The design of the new measure is still being debated; the authorities may opt for a full deduction or increase the risk-weighting. Any increase in capital requirements for banks that have foreign subsidiaries would have implications for UBS' business model.

Supervisors Could Gain Better Tools

The Swiss authorities plan to introduce forward-looking capital requirements for SIBs, similar to the Pillar 2 requirements that have long been set by supervisors in the EU and U.K. The authorities may also decide to make stress test results public.

In our view, changes such as the ability to set more-tailored capital requirements would give supervisors more options to address any shortcomings that are identified through stress testing. Broadly speaking, the powers available to Swiss supervisors would be on par with those available to their peers in comparable jurisdictions, such as the EU or U.K.

The proposals imply that the Swiss authorities are hesitant to reduce the use of external audit firms for supervisory work or to introduce fines. We note that supervision in other EU jurisdictions also makes increasing use of external audit firms.

Increased Capacity To Absorb Losses As A Going Concern

The recognition of additional Tier 1 (AT1) instruments as regulatory Tier 1 capital offers a source of risk-bearing capacity that can be tapped relatively early on, while a bank is still a going concern. The Federal Council is exploring options that could strengthen the ability of these hybrid capital instruments to absorb losses at an early stage. Other lawmakers are having similar discussions about how to enhance the ability of AT1 instruments to help stabilize a bank at an earlier point of distress.

One possible option is to introduce clearer rules governing the suspension of interest payments and restrictions on buybacks, should a bank report sustained losses. Alternatively, AT1 instruments typically set the trigger for equity conversion or write down at a common equity Tier 1 ratio of 7%; this could be increased to at least 10%.

The Federal Council has explored options such as allowing only convertible instruments, which would remove the possibility of a write-down feature. It has even reviewed the option of potentially removing AT1 instruments from regulatory Tier 1 capital. However, we understand that these alternatives were not included among the proposals that were put forward for consideration.

Closer Alignment On Accounting Standards And Prudent Valuation

The Federal Council has suggested tightening the standards on the prudent valuation and the recoverability of certain balance sheet items to align Swiss rules more closely with EU rules. This would affect the treatment of participations, goodwill, intangibles, and deferred tax assets. When Credit Suisse merged with UBS, certain of its assets had to be sharply devalued, by an amount that far exceeded the prudent valuation adjustment. This had a negative effect on its level of capital.

Increased Accountability For Individual Managers

One lesson learnt from the Credit Suisse case was that incentive structures could increase moral hazard. The authorities therefore propose revising the senior manager regime to enhance the accountability of individual decision-makers. For example, the Swiss Financial Market Supervisory Authority (FINMA) could be given the ability to associate one or more specific managers with misconduct, similar to the U.K. system.

In addition, the Federal Council has proposed tying variable compensation more closely to sustainable, measurable success; for example, by introducing vesting periods and claw-back mechanisms. The council explicitly stated that such measures could target staff at a wider range of Swiss banks, not just SIBs. The proposal would not introduce limits on the level of variable compensation allowed, in line with existing regulation.

Multilayered Defenses Against Deposit Run Risk

The Swiss authorities had decided in 2022 to tighten liquidity requirements--those changes came into effect in January 2024. However, the failure of Credit Suisse taught Swiss policymakers the importance of a multifaceted regulatory response to the issues presented by rapid, massive deposit runs. Metric adjustments cannot be the only means of addressing deposit run risk. It would not be feasible to require banks to hold sufficient liquidity to meet an outflow similar in size to the runs on Credit Suisse or U.S. regional banks.

Liquidity coverage ratio requirements for Swiss banks are higher than those in most other jurisdictions, including the EU. Therefore, we still expect the Swiss authorities to advocate at an international level for equivalent adjustments to the main liquidity requirements, particularly those related to the calibration of deposit outflows. Although this should provide additional protection, such a response can only go so far. Other lines of defense are needed.

As a second line of defense against liquidity stress, the Federal Council proposals emphasize the role of the central bank as a lender of last resort. The Swiss National Bank, like many other comparable central banks, has its function as a lender of last resort enshrined in its toolkit. The Swiss authorities would like to both increase the pool of available collateral and lower the stigma associated with accessing "last resort" facilities.

A third line of defense is also needed. The Swiss authorities envisage that this should take the form of a public liquidity backstop. The backstop would allow the central bank to lend to SIBs, in exceptional circumstances, without requiring collateral. Loans would be backed only by the security provided by preferential creditor rights in case of bankruptcy. Crucially, the proposal states that the backstop should be enshrined into law, rather than relying on being approved on an ad hoc basis using emergency powers. This measure has already been submitted to the Swiss parliament, in September 2023; we explored its consequences in "Swiss Public Liquidity Backstop Has Limited Implications For Hybrid Ratings," published on Sept. 18, 2023, on RatingsDirect.

Repercussions And Rating Implications

UBS already faces higher capital requirements when the Basel III rules are adopted in full on Jan. 1, 2025. These will require it to have a total loss-absorbing capacity of 27.6%. Adding the Federal Council's proposed measures to its other going-concern requirements would make these higher than those for many other globally systemically important banks in Europe. Switzerland's minister of finance estimates that UBS' revised capital requirements could have an additional impact of US$15 billion-US$25 billion, forcing the bank to build up further capital or reduce its risk-weighted assets.

Nevertheless, we consider most of the authorities' proposals on banks' corporate governance and supervision to be ratings neutral. Most of them simply align the Swiss regulatory framework with that seen in comparable global jurisdictions.

In general, we view having tighter banking rules compared with other regulatory regimes as positive, under our banking industry and country risk assessment (BICRA). However, the failure of Credit Suisse indicated that industry risk in the Swiss banking sector was higher than we had previously thought (see "Select Swiss Banks Affirmed After Review Of Banking Sector; BICRA Group Remains '2'," published on July 24, 2023). A strengthening of the BICRA would depend not only on stricter rules on paper, but also on a track record of timely and appropriate intervention by FINMA. In our view, applying the proposed rules would require a cultural change on regulation and we have yet to see how FINMA would apply its new powers, in practice.

At this stage, Swiss policymakers have yet to provide a final decision; instead, they have laid out multiple options. Some of the suggested changes--such as those affecting the capital framework or increasing the prescribed liquidity holdings--could have profound implications for Swiss SIBs' capital and balance sheet structure. If adopted, the higher capital requirements could bolster some of our ratings on Swiss banks and their hybrid instruments, in the medium- to long-term, by strengthening our risk-adjusted capital metrics. For now, we will wait and see which options make the cut.

Switzerland's multi-tiered banking system

FINMA uses a methodology similar to that of the Financial Stability Board to categorize domestic banks into different categories based on their total assets, assets under management, privileged deposits, and required capital. Supervision then depending on the categorization. Less-significant institutions can benefit from reduced calculation and disclosure obligations under Switzerland's small banks regime. Midsize banks, such as cantonal banks, are subject to more-continuous and intensive supervision. Extremely large, important, and complex market participants are subject to higher capital, liquidity requirements and may also be required to prepare resolution strategies.

Except for the governance measures, we anticipate that the recent proposals will affect only SIBs, and that there will be some differentiation between global SIBs (banks that have an extensive international reach) and domestic SIBs (those that have a domestic focus).

UBS is the only global SIB in Switzerland. The domestic SIBs are:

• PostFinance, the banking arm of the Swiss postal service;
• Raiffeisen Group, the head organization of the Swiss cooperative sector; and
• Zuercher Kantonalbank, which is owned by the canton of Zurich.

How Would Swiss Regulators Address Future Resolution Cases?

The Swiss authorities, and Credit Suisse itself, had spent several years making preparations for a potential resolution. Nevertheless, in the event, decision-makers made a pragmatic decision to merge Credit Suisse with UBS instead of implementing a formal resolution process.

Some were concerned that this decision signaled a change in the Swiss authorities' approach to crisis management for too-big-to-fail institutions. However, we did not subscribe to this view at the time, and the authorities later confirmed that they had no plans to make substantive changes to the regulatory framework. This supports our analytical approach; our base-case scenario still assumes that distressed systemic banks in Switzerland would be subject to a formal resolution.

The proposed changes represent a strengthening of the crisis management framework and pointedly demonstrate the Swiss authorities' future intentions:

• Strengthening the early intervention powers granted to supervisors would ensure that regulators could make more-proactive decisions if a bank's financial situation were to deteriorate.
• Expanding the resolution options grants the authorities even more flexibility at the point of failure (for example, giving them the option of mandating an orderly wind-down).

In our view, these measures incrementally improve the Swiss resolution framework because they provide a wider range of tools to be used in distress.

Getting Through The Parliamentary Process Will Take Time

Before taking effect, the Federal Council's measures could pass through various legal stages. Initially, they would be simple FINMA expectations. Thereafter, we could see changes to the ordinances and, finally, following parliamentary approval, the measures could be enshrined in law through an act of parliament. The proposals relating to supervision could go through this process largely intact. For those aspects related to liquidity and capital requirements, the proposals are less specific and there is greater uncertainty regarding the exact scope of the changes. Implementation of some of the proposals could be delayed if they are put to a public referendum before being enshrined into law; this could occur if there is increased public interest in the proposals. We do not expect most of these measures to come into effect before 2025. Even then, we consider the changes likely to be subject to a phase-in period, similar to that applied during the implementation of Basel III.

Related Research

• Your Three Minutes In Banking: Higher Minimum Reserve Requirements Will Dent Swiss Banks' Profits, April 26, 2024
• Top European Bank Rating Trends In 2024: The Future Is Now, Jan. 24, 2024
• Swiss Public Liquidity Backstop Has Limited Implications For Hybrid Ratings, Sept. 18, 2023
• Select Swiss Banks Affirmed After Review Of Banking Sector; BICRA Group Remains '2', July 24, 2023
• Swiss Public Liquidity Backstop For Banks Comes With Strings Attached, July 17, 2023