Sandro Schmid has many years of experience in bank risk management and once worked for Credit Suisse. UBS should think twice before putting shareholder value above everything else when integrating Credit Suisse, the banking consultant tells finews.asia.

Mr. Schmid, following the demise of Credit Suisse, the question of who is to blame is being raised ever more loudly. You worked in risk management for banks for a long time and now advise the financial sector. What really caused the bank to go under?

I find it interesting that Credit Suisse's risk management is often primarily blamed.

Why is that?

A risk is always the result of a business. A business model is run based on a strategy, a culture, incentives, and, of course, people. This gives rise to risks that need to be understood and managed. For example, in the Archegos case, a position of $24 billion was built up which represented more than half of the equity of the Credit Suisse Group. In this respect, I find discussions related to the business model more informative than a one-sided view of risks.

What does that mean in the case of Credit Suisse?

If you go back in time, it was during the era of former Chairman Rainer Gut the bank decided to enter the investment banking business in a big way. That's where the bank got into the biggest trouble, while its traditional Swiss business remained stable and attractive throughout. The last incidents occurred in asset management, where the Swiss Financial Market Supervisory Authority (Finma) identified major deficiencies in risk management. Nevertheless, not everything was bad in risk management, and loss risks were identified and communicated at an early stage. Today, this can be read in part from the reports of the supervisory authority...

...but?

But decisions were made in favor of the hoped-for returns, and not to reduce risks.

You mentioned incentives, such as the exorbitant bonuses paid to ex-Credit Suisse CEO Brady Dougan. Did the special bonuses blind bankers to risk?

The bonus culture certainly played a latent role. People took big risks to secure their bonuses. They simply wanted to earn even more money. The management, even those in finance, must accept the accusation of having tuned the business model for high bonuses and then not having had a grip on it in the end.

«No one is so smart that he or she should earn several million a year»

However: Credit Suisse finally went under because of a bank run. That's a risk that doesn't normally feature among the top ten in a bank's risk management.

But this bonus culture will be perpetuated at the combined UBS, won't it?

You have to assume that it will continue to be comparable at UBS. The compensation structures of the banks are similar. Members of the executive board and the managing directors at UBS are paid high salaries and bonuses which is unhealthy in my opinion. Nobody is so smart that he or she should earn several million a year, not even in banking. However, Finma has reacted and recently imposed new requirements on UBS and Credit Suisse to counteract this incentive problem in a risk-based way.

At UBS it's often argued the best talent can only be tied to the company with correspondingly high wages.

Those who draw the comparison with international wage levels should ask themselves whether this argument is still valid in light of today's incidents. I would like to note that this bonus culture did not exist in Switzerland in the past before it was imported from the US. Banks had done quite well before, and even today, smaller and medium-sized Swiss banks can find good people without excessive bonuses. Those were the days when a banker was still respected in society.

Credit Suisse, or rather the private bank Clariden Leu, was also one of your career stops. You experienced the culture, or lack thereof, there yourself. Was everything really that bad?

Of course not. My time at Credit Suisse and Clariden Leu was very nice. But the culture back then can hardly be compared with that of recent years. I still remember when the bonus culture was introduced, though.

«From a risk management perspective, a bank is never too big per se»

You have to know that before, employees were only paid a thirteenth month's salary. Hardly anyone was fired either. Those who didn't meet expectations were trained or transferred internally. Staff turnover was minimal, and employees were happy without fear of losing their jobs.

That seems like a very long time ago...

The culture has changed extremely over the past 20 years. However, there has never been a single culture, but depending on the division, whether investment banking, private banking, corporate banking, and so on, the culture of Credit Suisse was lived differently. In summary, I would say that the culture was not bad per se, but had different characteristics and was subject to strong changes.

The combination of UBS and Credit Suisse has created a much bigger bank, one that is too big in terms of the risks for Switzerland and its financial center.

From a risk management perspective, a bank is never too big per se. It would only be too big if Switzerland's risk appetite is not big enough. And we don't know what that appetite is. Nor is the ratio of UBS's total assets to Swiss GDP necessarily very meaningful. But what should be discussed...

...that is?

That's the question of who will rescue the combined UBS if it gets into trouble again. In the case of Credit Suisse, it became clear in March that the state, which saved UBS in 2008, no longer had the confidence to stabilize Credit Suisse on its own. It obliged UBS to do so. But even this major bank will never be free of risks.

That's the million-dollar question: Who will save the combined UBS one day?

Unfortunately, the scenario of UBS going bankrupt cannot be completely ruled out. It should also be borne in mind that the state cannot dictate to UBS, as a private company, how it should do business. What if, in five years, the bank concludes that there's more money to be made in investment banking after all?

«We could end up like Iceland in its banking crisis»

If there were to be major problems, there would no longer be a place where the solid business could be shifted. If UBS now fully integrates Credit Suisse, as could be the case at the end of August, a rescue of the kind we experienced with Credit Suisse will hardly be possible. This is not the only reason why UBS should think twice about shutting down the Credit Suisse platform.

What do you mean?

I think the question of how to «recovern» the combined UBS is central. If Switzerland can no longer save its largest bank, then we could end up in a similar situation to Iceland in its banking crisis. I don't want to paint in somber tones, since UBS is substantially more stable today than it was in 2008, thanks in part to the downsizing of the investment bank and highly professional risk and compliance management. In this respect, the risk of a new crisis with the current business model appears to be very low. However previous banking crises have shown that the danger rarely comes from where one would have suspected it. Identifying new major risks at an early stage is something of a freestyle in risk management.

A bank run has been Credit Suisse's undoing. In that respect, private banking is not quite so risk-free either, is it?

It was the wealthy private clients, the institutional investors, and the external asset managers who withdrew a lot of money from Credit Suisse very quickly. A bank run could also bring the combined UBS to its knees.

You're saying that the preservation of Credit Suisse Switzerland would remedy this in an emergency?

At least UBS and Switzerland would have additional maneuvering room in a crisis. What is also still hardly discussed is the question of IT.

Why would that be important?

Big bank systems cannot simply be switched off or transferred. They are systems comparable to neuronal networks with numerous layers. If just one thing is changed, this can lead to unforeseen consequences.

«The safest thing would probably be to let the IT of UBS and Credit Suisse run side by side»

It's no coincidence that the big banks run their systems in three versions, in addition to the backup: one version is running, one is being further developed, and one is being tested.

A transfer from the one big bank IT of Credit Suisse to that of UBS is impossible?

A task of this magnitude has never been carried out before. The transfer of hundreds of thousands of customers would require technical solutions - this is also uncharted territory and incredibly complex because a core banking system of this size cannot even be described. The Swiss retail business in particular is highly automated. It can be almost more expensive to integrate a single customer than to do without customers and their earnings. In the case of a transfer, the risks and costs would be enormous. If UBS manages to do this within four years, I would be very surprised.

What would be the alternative?

The safest option would probably be to let UBS and Credit Suisse's IT continue to run side by side. But that would mean much higher costs, but also keeping jobs. That quickly raises the efficiency question. UBS shareholders won't want that.

Everyone is waiting in suspense for the end of August when the decision on the future of CS Switzerland is to be made. Full integration into UBS is considered the most likely scenario. But what are the risks?

As I said, for IT reasons alone, I think integration by switching off Credit Suisse's computing system and booking all clients with UBS is risky and extremely expensive. At the same time, the only reason in favor of integration is to increase efficiency with the prospect of more profit. But Switzerland then lacks a system for a bad bank. In my opinion, UBS, which has already been rescued once by the state, should think twice before putting shareholder value above everything else when dealing with Credit Suisse Switzerland. The person who has to take responsibility for this integration is faced with an incredibly complex matter.

UBS CEO Sergio Ermotti has to make these decisions.

That's the right thing to do. And whatever he and his team decide, whether a transfer of the systems or parallel operation, the consequences cannot be assessed for years to come. I wouldn't want to be in his shoes at that moment.

Sandro Schmid is a partner and member of the executive board of the consulting firm LPA in Zurich. He is considered both an expert in the use of future technologies such as artificial intelligence and risk management, the latter also as a board member of the Swiss Risk Association. In his wide-ranging career, Schmid spent around 15 years at Credit Suisse or its former private banking subsidiary Clariden Leu.