Saturday, October 16, 2010

"Swiss Finish" to New Global Capital Rules

Economist: First Mover
Financial Times: Swiss urge capital boost for banks
NYTimes: 2 Swiss Banks Facing Higher Capital Standards
WSJ: UBS, Credit Suisse Face Tough New Capital Rules

Last month, global regulators reached an agreement on new capital rules for banks. Under the new Basel III rules, banks are required to hold core capital of minimum 7 percent of risk-weighted assets. The Basel Committee on Banking Supervision also recommended that the top 30 global banks should hold more capital in addition to the minimum requirement. On October 4th, Switzerland made the first move. The proposals by the Commission of Expert (Commission) require the two "systemically important" banks, Credit Suisse and UBS, to hold 19 percent of risk-weighted assets (10 percent in the form of common equity plus 9 percent of contingent convertible bonds (CoCos)). CoCos are similar to bonds but convert to equity if core capital ratios falls below a predefined level. The Commission, appointed by the government, was comprised of representatives from the central bank, industry, etc. If the Parliament approves the proposals, the two banks must comply with the new rules by 2019.

The proposed rules will "significantly mitigate the too big to fail problem in Switzerland and thus reduce the risk for the Swiss economy," said Philipp M. Hildebrand, Chairman of the Swiss National Bank (SNB) Governing Board. According to the Commission, the total capital requirement of 19 percent makes sense given the size of Credit Suisse and UBS and their potential impact on the economy. The balance sheets of the two banks amount to around six times the nation's gross domestic product. Also, during the financial crisis (from the last quarter of 2007 to the first quarter of 2009), UBS incurred losses of 13 percent of risk-weighted assets.

Both Credit Suisse and UBS confidently say that they can meet the heightened requirement by 2019. However, experts disagree over the practicalities of CoCos. John Cryan, UBS's financial director doubts whether a CoCo market would emerge or whether banks can use it. Only two banks, Lloyds and Rabobank, have used CoCos so far, issuing around $16.4 billion last year. Credit rating agencies have not been willing to rate CoCos. On the other hand, Thomas Jordan, director of the SNB, is confident that investors will buy CoCos. According to the Economist, CoCos can be viewed as "a kind of catastrophe insurance for which a premium is received in return for a small chance of a big loss," and banks will be able to use CoCos. The Commission estimates that if Credit Suisse and UBS use CoCos to raise 9 percent of their risk-weighted assets, the amount would be approximately SFr 72 billion.

1. Jose-Maria Roldan, head of banking regulation for the Bank of Spain, said that CoCos are "brilliant ideas but... preferred shares and subordinated debt also looked great before the crisis and they were totally useless. Why do we think financial innovation will work this time around?” What are the benefits and disadvantages (or risks) when banks use CoCos to raise capital?

2. The Commission heightened the capital requirement, but did not propose to break up the two biggest banks or limit their size or activities (e.g., proprietary trading) Should the Commission have suggested breaking up the two banks or limiting their size or activities in order to address the too-big-to-fail problem?

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