A decade ago, Switzerland’s two largest banks were involved in a risky race to take on the biggest investment banks in Wall Street.
Having learnt lessons in the financial crisis, UBS and Credit Suisse are now focused on the delicate task of scaling down both their risky assets and the business lines that trade them.
Prompted by tough new Swiss regulations that will come into force from March 1, UBS said it plans to cut its risky assets by half by the end of 2016. Earlier this month, Credit Suisse announced that it was well ahead in its own ambitious risk reduction programme.
“Both banks are far ahead of the rest of the banking sector and both are currently well capitalised,” Bank Sarasin analyst Rainer Skierka told swissinfo.ch.
UBS and Credit Suisse can also fall back on powerful wealth management franchises and solid retail bank operations to keep them stable when markets are volatile.
Shaky results
But ratings agencies are not yet impressed, giving both banks broadly the same chances of defaulting as most other international peers. In addition, the agencies remain cautious about the prospects of the Swiss institutions.
In February, Moody’s warned that it was contemplating the downgrade of 17 banks, with UBS and Credit Suisse at risk of being pushed down by three notches.
This scepticism can in large part be put down to the poor results both banks reported in the second half of 2011. Annual revenues and profits were far below 2010 levels at both banks, disappointing analysts’ expectations.
With income largely arriving in dollars, and expenditure paid out mostly in Swiss francs, margins are being squeezed at both banks. The strong franc also dilutes the value of assets accumulated from Swiss-based retail operations.
In a note released last November, Moody’s said it was nervous about declining profitability in wealth management, coupled with investment banking operations that are still big enough to attract problems.
“As a result of the declining profitability of the bank’s wealth management business, stemming from the strong Swiss franc, low interest rate environment and cautious client behaviour, Credit Suisse has become more reliant on its investment banking business,” Moody’s David Fanger said.
Proof in the pudding
And there is uncertainty about how much further the United States and the European Union can squeeze Swiss banking secrecy, causing damage to Switzerland’s wealth management industry.
“Regulatory, litigation and compliance costs are going up while revenues will be stable or negative,” Christian Kündig, an analyst at Fitch ratings agency, told swissinfo.ch.
Fitch is also waiting to see how other countries’ regulatory changes that are still being fine-tuned compare with Switzerland’s model.
“As things stand, Swiss regulatory requirements are tougher than international standards, but many international regulatory frameworks may yet end up fairly close to Swiss levels,” Kündig told swissinfo.ch.
In addition, Fitch remains to be convinced that UBS and Credit Suisse can succeed in reducing risk while maintaining profitability.
“Implementation of this exit strategy will be challenging as many of their peers are doing the same thing,” said Kündig.
Herd mentality
The fact that most large scale banks around the world will be forced to shed risk at more or less the same time has complicated the operation. Royal Bank of Scotland and Barclays recently announced plans to get rid of assets, and it will probably not be long before other banks join the mass fire-sale.
Under such conditions, shedding risk could be just as dangerous as taking it on in the first place. Credit Suisse said it lost SFr981 million ($1 billion) from selling assets and exiting businesses in the last three months of 2011.
“Downscaling is a positive for banks, but it is also a balancing act,” Rainer Skierka told swissinfo.ch. “The dilemma is that if a bank reduces risks too aggressively, it gets a lower price on its positions. This pushes back efforts to build up capital as it eats into the bank’s capital base.“
“If buyers know that banks have to sell, then who is going to pay market rates?” he added.
Safety, rather than aggression, has become the biggest selling point, and the tone of both Swiss banks has changed from being the boldest on the street to the most reliable.
This claim would carry far greater weight than just an idle boast, according to Rainer Skierka.
“A strong capital base is these days a big plus in the context of the wealth management business,” he told swissinfo.ch. “Wealthy individuals will only do business with banks that have a top of the league capital ratio [capital buffer against risk].”
But achieving this reputation as the safest banks of their class could in itself prove to be a risky operation.
The financial crisis, and subsequent bailout of some banks using taxpayers’ money, prompted a rapid review of financial regulations around the world.
Various proposals to prevent gambling by banks from infecting the real economy have been outlined.
The Basel Committee on Banking Supervision has recommended that banks hold more capital than before the crisis (equal to 8.5% of risky assets by 2019), and of a superior quality, to act as a buffer against future shocks.
Switzerland will enact its own enhanced regulations from March 1 that call for UBS and Credit Suisse to retain a capital buffer of up to 19% of its risky assets by 2019.
In the US, the Volcker rule would restrict banks gambling their own money on the financial markets – known as proprietary trading.
The Volcker rule has been hotly disputed by both US and international banks and has yet to be made into law.
British legislators have been asked to vote on the Vickers reforms that would ring fence retail operations from more risky trading operations. If passed, a bank would no longer be able to gamble the deposits of ordinary account holders in risky trades.
The EU – led by France and Germany – is pushing for a new financial transactions tax, but this measure is being resisted by Britain.
Some countries are also looking at the issue of regulating the trade in derivatives and the so-called shadow banking business, made up of financial entities such as hedge funds.