What could be safer than a Swiss bank? Despite its reputation for stability, the bankruptcy of Credit Suisse in 2023 exposed the weakness of the Swiss banking system.
This article examines the initiatives of Swiss authorities to restore confidence in their banking system. As mentioned in a article Previously, the Public Liquidity Backstop (PLB) is a measure introduced to protect Swiss systemically important banks against a bank run. Conceived before the arranged marriage between Credit Suisse and UBS, the PLB will finally come into force in 2025. However, this measure could have an unexpected impact that needs to be examined. So how did Credit Suisse (CS) collapse in the first place?
Glance in the rearview mirror
In March 2023, a small California bank failed, triggering panic among investors, who looked for the next weak link in the banking sector[1]. Their attention quickly turned to Credit Suisse, weakened by repeated scandals and poor results for years. Anticipating a fall in the stock, they massively sold their shares, plunging CS into a vicious circle. The forced merger between UBS and CS was widely publicized and its outcome considered generally positive. However, the PLB has three major flaws.
First, if the PLB applies in its current form, systemic banks in difficulty will no longer be able to pay dividends, sending an alarming signal to the markets that would worsen the vicious circle. Since dividends are an integral part of a stock’s value, a legal ban on their payment could reduce the company’s market capitalization and accelerate the snowball effect.
When regulators force a bank to stop paying dividends
In an efficient market, investors incorporate all the information available to them into prices. Otherwise, there is “information asymmetry” and they would anticipate that a bank in difficulty will suspend its dividends. A law imposing this stop would be superfluous if already anticipated or even harmful if the bank can continue to pay thanks to its reserves. If a bank with reserves is prevented by the PLB from paying dividends, this could cause its stock price to fall, thereby exacerbating negative procyclical dynamics. In addition, current Swiss law already regulates these suspensions, so new legislation would risk creating confusion and rigidity.
Finally, the PLB could unfairly penalize shareholders, who are often small, numerous and far from management decisions, while their support is crucial in times of crisis. Although justified, blocking dividends in the event of public aid risks, in practice, accelerating bankruptcies.
Share the risk, distribute the danger
The second weakness of the PLB lies in the annual tax based on the risk of failure of a systemic bank (art. 32c PLB). According to art. 32c, par. 3, this package depends on the potential losses for the Confederation in the long term and the results of the banks. The amount of the package is linked to the risk incurred by the bank (in accordance with Basel standards), which, due to the interconnection of banks, creates a strong incentive for collusion.
If one Swiss systemic bank (UBS, Raiffeisen, ZKB, PostFinance) experiences turbulence, the others may be exposed. A decline in the value of one bank’s assets can benefit others. However, any increase in value increases the amount of the package. They could therefore circumvent the PLB by buying back the shares of the sick bank, considered liquid in the LCR. But this could violate antitrust laws, strengthen the keiretsu effect and increase market concentration. Worse, a possible domino effect: mutual aid could lead to collective shipwreck. What seems logical actually hides an underlying danger.
It’s the type of remuneration that counts
Furthermore, Article 10a of the Banking Act entrusts the remuneration policy of banks in difficulty to the Federal Council, which may dissuade the best managers from applying in favor of the riskiest profiles. Managers, investing their money and their work in the company, are linked to its future without the possibility of diversifying this risk[2]. The structure of their remuneration influences their risk taking. The promise of a bonus if the bank’s stock price rises could push managers to make risky bets, while a fixed salary reduces this temptation and promotes stability. It is therefore the type – not the amount – of remuneration that guides risk-taking.
A warning for the PLB
These three points call for caution. Despite a need for reform after twenty years of financial turbulence in Switzerland, the legislative modification proposes common sense adjustments and political responses, without real economic analysis à la Posner. This shows that seemingly fair or useful measures can be counterproductive or even harmful. The PLB risks missing its target and must be adjusted to incorporate a more economical approach.
Article original: https://hospitalityinsights.ehl.edu/banking-regulations-switzerland
[1] Bianchi, par. All eyes now on Credit Suisse collapse.
[2] Hall/Murphy,p. 8.
