Thought reform and measures proposed in the Swiss banking sector by the Report of the Expert Group on Bank Stability (2023)
In March 2023, the Federal Council, the Swiss National Bank (SNB), and the Swiss Financial Market Supervisory Authority (FINMA) had to intervene urgently to safeguard the Swiss economy. A package of measures was adopted on March 19, 2023, which averted potential damage to the Swiss financial system.
In this context, the question of how the resilience of systemically important banks can be further strengthened has been raised. This has been addressed in the much-awaitedReportof the Expert Group on Bank Stability published on 1st September 2023 (Report) as well as lately, by the Basel Committee on Banking Supervision. In this context, the proposed introduction of the Public Liquidity Backstop (PLB) for systemically important banks (SIBs) will also be a crucial step to enhance banking stability. These recommendations and measures will have significant implications for financial institutions in Switzerland, presenting both opportunities and challenges, which will need to be carefully considered.
Thought measures for the Swiss banking sector
Considering the recent events, doubts about the efficiency of the “Too-big-to-fail” (TBTF) regime were raised.
As a reminder, in Switzerland, theSwiss Banking Actand theSwiss Banking Ordinance prescribespecial requirements for SIBs, including, in particular, the preparation of emergency plans to ensure the continuation of systemically important functions in a crisis independently of the other parts of the bank. An SIB must also prepare a recovery plan to stabilize itself so that it can continue its activity without state intervention. Further, the FINMA is responsible for drawing up resolution plans to carry out the restructuring or winding-up of SIBs and may unilaterally order the activation of these plans in a crisis.
The Federal Department of Finance (FDF) established the Expert Group on Bank Stability on May 17th 2023, to analyze March 2023 events and come up with measures for the Swiss banking sector. The Expert Group's Report presents several recommendations or opinions as a basis for the expected projected measures (parliamentary postulate, 23.3443). It is divided in 4 categories (i.e., crisis management, liquidity, monitoring & protective measures as well as equity).
The key proposed measures in relation to the Swiss banking sector reform are summarized below (see or click below for details relevant to each category).
3.Monitoring and Protective Measures
In October 2023, thereportof the Basel Committee on Banking Supervision on the banking turmoil that started in March 2023 provided as well valuable insights on the initial lessons learnt therefrom. In particular, it was noted that a rules-based supervisory approach is insufficient and there is a need for supervisors to exercise judgment and proactively intervene even when specific regulatory capital or liquidity ratios have not been breached. Further, the importance of assessing the effectiveness of a bank’s corporate governance and risk management framework was also underscored. With respect to banking groups, it was highlighted that the risk dynamics throughout the group, including at an entity or sub-group level, should be regularly monitored. Regarding banking regulation, possible issues with the design and operationalization of the Basel III liquidity standards, namely the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), were identified in addition to possible shortcomings of the current regulatory treatment of the interest rate risk in the banking book (IRRBB) in the Basel framework. The report also underlined the need to further assess the complexity, transparency, and role of AT1 instruments in a holistic manner. Of note, it was observed that the distress of relatively small banks (which are not subject to the full Basel III Framework) can trigger broader and cross-border contagion effects, and this may require a review of the general application of the Basel framework for non-internationally active banks.
In December 2023, FINMA’s Report “Lessons Learned from the CS Crisis” also reflects on identified areas in which FINMA believes that an extension of the legal framework or clarification of the implementing provisions needs to be discussed, or where it will make selective adjustments to its supervisory activities. However, FINMA notes that it will never be possible to subject financial institutions to supervision that is 100% watertight. Even with greater regulation and extended supervision there is no guarantee that a financial institution will not fail. However, the possible solutions reduce the probability and impact of a failure. FINMA’s findings are also being incorporated into the Federal Department of Finance’s ongoing comprehensive evaluation of the TBTF rules and regulations.
Public Liquidity Backstop (PLB)
In addition to the above, on the 6th September 2023, the Federal Council adopted the introduction of aPLB for SIBs. Under the PLB mechanism, if an SIB under resolution does not have any other options to finance itself and has insufficient collateral to apply for an ELA, the SNB may grant additional liquidity, on the basis of a guarantee provided by the Swiss Confederation. It may grant the default-risk guarantee at its discretion, considering the risks associated with the granting of the guarantees against the risk of default. The introduction of the PLB has a two-fold rationale. Firstly, it ensures continuation of systemically important functions in cases where the bank is unable to finance itself and the ELA provided may not be sufficient. Secondly, it prevents the loss of confidence, so that its very existence helps to avoid the need to activate it. Indeed, the mere possibility of granting additional liquidity with a default risk guarantee will have a preventive effect on the market and avert, if necessary, an SIB from being stormed by depositors.
An SIB shall be required to pay an ex-ante, risk adjusted lump sum to the Swiss Confederation every year, as a compensation for the risk of loss that the latter may be exposed to, on account of the default risk guarantees granted under the PLB. The lump sum payments must be made annually regardless of whether the liquidity support under the PLB is granted. Further, risk premiums and interest costs are payable on loans disbursed under the mentioned PLB and accrue for as long as the aid remains. As such, the introduction of the PLB will involve significant cost implications for SIBs, which will also serve to offset the competitive advantages they enjoy over Swiss banks without systemic importance.
The implementation of the PLB in Switzerland aligns with international best practices standards and will help in enhancing the stability of the banking sector. The introduction of the PLB should strengthen Switzerland’s current position as one of the most stable international banking centers despite recent events, increase confidence on the part of foreign supervisory authorities in Swiss G-SIB and also address potential competition imbalances that could negatively affect Swiss G-SIB by ensuring a competitive level playing field with their foreign counterparts of major financial centers. Furthermore, it should reinforce investors’ and customers’ confidence in the resolution capacity of an SIB. The confidence gain will also improve the scope for refinancing on the market. However, the introduction of the PLB may involve cost implications for SIBs due to the lump sum and premium payments.
Potential future implications for Swiss banking sector
While increased coordination between the SNB, the FINMA and the FDF in connection with crisis management and the reinforcement of FINMA’s position, would lead to an improved support for banks, it may also result in increased regulatory compliance and public scrutiny.
The proposed measures seek to further empower FINMA to impose sanctions for violations of regulatory ratios, thereby enhancing its enforcement capabilities by broadening the range of proactive and protective measures available to it, allowing for greater intervention.
Of note, the FINMA is the only prudential supervisory authority at an international level that cannot impose fines. Empowering the FINMA in this regard, would drastically change the consequences for non-compliance by Swiss financial institutions, constituting a powerful monetary incentive. Besides financial liability intended as a dissuasive measure, the proposed introduction of the “Senior Manger Certification Regime” would enable FINMA to penalize senior bank managers or other actors that could harm the financial place due to their risky activities and decision-making power, by establishing a causal link between acts or omissions of managers and serious breaches of supervisory law - in other words, implicating their personal responsibility. Further, the publication of enforcement procedures under a “Naming and Shaming” form as used already in the United Kingdom would require from financial institutions a possible review of their risk appetite - given that the public is, at the moment, largely unaware of the true position of a non-complaint financial institution - due to increased public scrutiny and consequently, pressure.
The above could lead to restructuring of business lines, changes in governance as well as improvements in risk management systems, consuming considerable efforts and costs. The recommendations laid out in the Report, if pursued, would have undeniably a considerable impact on the Swiss banking sector.
As an expert in banking and financial regulations, I bring a wealth of knowledge and experience to shed light on the complex landscape of the Swiss banking sector and the measures proposed in the Report of the Expert Group on Bank Stability in 2023.
Firstly, it's crucial to highlight the context that led to the intervention of the Federal Council, the Swiss National Bank (SNB), and the Swiss Financial Market Supervisory Authority (FINMA) in March 2023 to safeguard the Swiss economy. This intervention resulted in a comprehensive package of measures adopted on March 19, 2023, aiming to avert potential damage to the Swiss financial system.
The subsequent Report of the Expert Group on Bank Stability, published on September 1, 2023, became a cornerstone in addressing the resilience of systemically important banks (SIBs) in Switzerland. This report, alongside insights from the Basel Committee on Banking Supervision, laid the foundation for proposed reforms in the Swiss banking sector.
The proposed introduction of the Public Liquidity Backstop (PLB) for SIBs stands out as a crucial step in enhancing banking stability. The PLB mechanism, adopted on September 6, 2023, provides a means for SIBs under resolution to access additional liquidity with a default risk guarantee from the Swiss Confederation. This mechanism not only ensures the continuation of systemically important functions but also acts preventively by instilling confidence in the market, thereby averting a crisis.
The Report categorizes proposed measures into four key areas: crisis management, liquidity, monitoring and protective measures, and equity. In the realm of Monitoring and Protective Measures, insights from the Basel Committee underscore the importance of a judgment-based supervisory approach, moving beyond rules-based methodologies. The report emphasizes the evaluation of a bank's corporate governance and risk management framework and the need for regular monitoring of risk dynamics within banking groups.
Additionally, concerns are raised regarding the design and operationalization of Basel III liquidity standards, such as the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). The report suggests a comprehensive assessment of the complexity, transparency, and role of Additional Tier 1 (AT1) instruments.
Furthermore, the report highlights findings from FINMA's "Lessons Learned from the CS Crisis" in December 2023, indicating areas for potential legal framework extensions and clarifications in implementing provisions.
The introduction of the PLB is not without its challenges. While it aligns with international best practices, the associated costs, including ex-ante lump sum payments and risk premiums, pose financial implications for SIBs. However, these costs are seen as necessary to offset competitive advantages enjoyed by SIBs over other Swiss banks.
Looking ahead, the proposed measures, if pursued, could have far-reaching implications for the Swiss banking sector. Increased coordination among regulatory bodies, empowerment of FINMA to impose sanctions, and the introduction of the "Senior Manager Certification Regime" could reshape the regulatory landscape, enhancing enforcement capabilities and increasing accountability.
In conclusion, the proposed measures, outlined in the Expert Group's Report, demonstrate a comprehensive and forward-looking approach to strengthen the Swiss banking sector. These measures address not only the immediate concerns but also lay the groundwork for a more resilient and accountable financial system in Switzerland.