Due to Credit Suisse's failure, Swiss parliamentarians are demanding, among other things, more robust capital buffers. But even the strictest capital ratios in the world won't eliminate banking crises.

At the special parliamentary session that began Tuesday, there were not only calls for the government to take legal action against the management of toppled Credit Suisse but also demands to revise too-big-to-fail rules for systemically important banks.

In particular, capital and liquidity requirements to which Swiss banks are subject were the topic of debate. Various politicians argued for a significant increase in capital buffers to prevent a banking collapse like that of Credit Suisse «once and for all.»

Storm at the Center

The most outspoken of all was the president of the centrist «Die Mitte» party, Gerhard Pfister. He channeled the mood of crisis in parliament caused by the collapse of Credit Suisse and staked a position demanding Swiss banks hold at least 20 percent equity capital in the future.

The higher the equity ratio of a bank, the better it can stop bankruptcy and retain the trust of its customers, was the simple message.

Academic Support

Pfister received prominent support for his 20 percent demand from Christoph Schaltegger, director of The Institute for Swiss Economic Policy (IWP) at the University of Lucerne, who wrote in the «NZZ am Sonntag» (in German, behind paywall), that the shareholders of a larger bank should provide hard equity of at least 20 percent of the total balance sheet.

In Schaltegger's view, this makes the bank more solvent and at the same time less attractive for risky transactions, because losses from them can no longer be passed on to the general public, but must be absorbed by the equity capital.

Costly Downside

But such high capital requirements come at the expense of profitability, precisely because they are expensive.

McKinsey's Global Banking Review noted the cost of equity for banks averaged around 9 percent over many years. Last year, only half of the banks exceeded this cost with their returns on equity. According to the consulting firm, the proportion of banks not able to recoup these costs will increase. Things could get uncomfortable if, in a global recession, returns on equity could fall significantly to 7 percent by 2026, and even to 6 percent in Europe and could trigger the next banking crisis.

A Regulatory Wake-up Call

Given such realities, it is a delicate balancing act to find where the sweet spot of the optimal equity cushion.

The Swiss Bankers Association (SBA) takes a similar view. The industry association told finews.com the events surrounding the downfall of Credit Suisse must be discussed comprehensively and transparently, with all parties involved, before statements on measures can be made.

According to the SBA, the review should cover the entire interaction between the bank, the authorities, existing regulations, and prevailing market dynamics. Resulting recommendations need to take into account the existing proportionality and be based on differentiated regulation.

The Swiss Financial Market Supervisory Authority (Finma) also wants to carefully review the events. It must be examined where and how the regulatory requirements for systemically important institutions can or must be improved in a targeted manner, the authority wrote in response to a query.

2008 Financial Crisis Lessons

Switzerland currently has two types of capital requirements in line with international standards. There are weighted requirements, calculated as a percentage of risk-weighted asset positions (RWA ratio, Risk Weighted Assets). There are also requirements for unweighted capital ratios, calculated as a percentage of total exposure, resulting in a leverage ratio (LR) requirement that serves as a safety net.

Following the 2008 financial crisis, it was vowed that systemically important banks in particular would hold much more equity. At the time, an LR rate of ten percent was bandied about. But that was then. According to Basel III international regulatory standards, hard equity must now amount to at least three percent of total assets. Swiss requirements are somewhat higher, with a minimum of 4.5 percent for big banks. This is now.

Stricter Swiss Rules

All systemically important banks in Switzerland including UBS, Credit Suisse, Zuercher Kantonalbank, Raiffeisen, and Postfinance, need to have more regulatory capital than other banks to provide a buffer against unexpected losses.

In terms of capital, the systemically important banks are required to hold a capital ratio of 3.5 percent in common equity tier 1 capital (CET1) in the normal case supplemented by 1.5 percent in perpetual debt instruments that can be converted into core capital relatively quickly in the event of losses like high trigger coco-bonds (AT1).

No Panacea

No matter how hard the screws are tightened and the strictest capital ratios in the world, no bank is safe from going under.

The latest unfortunate example of this is Credit Suisse. It collapsed not because of insufficient capital, but because confidence in the strategy developed by the board of directors and in the operational skills of management was lost.

In the final act of the drama, without drastic measures, a disorderly bankruptcy would have been imminent. Federal Councillor Karin Keller-Sutter summed up the situation at the special session, saying «It was clear to everyone that liquidity alone would not have been enough.»

Dealing With Risk

Parliament should ask itself with the same fervor with which it rages about the failures after the demise of Credit Suisse and calls for more capital, what it can contribute to training the most capable people in the financial sector, for whom dealing with risk is a substantial part of their calling.