Swiss approach to tacking too big to fail (TBTF) problem

Thomas Jordan of Swiss National Bank gives this nice speech on the topic. The detailed report is here.

He says the idea is not to stifle financial firms. But to protect taxpayers money:

Eighteen months ago, we here in Switzerland tackled a major challenge: the search for a solution to what is known as the ‘too big to fail’ problem in the current financial system. ‘Too big to fail’ means that the state has no choice but to rescue a company because its demise would seriously affect the entire economy. In good Swiss tradition, a broad-based committee of expertspresented the Federal Council with a proposal supported by all in-volved parties and the implementation of which would significantly alleviate the ‘too big to fail’ problem. This proposal was, in essence, approved by the Federal Council and has been put before Parliament in the form of a draft law.

At this point, I should like to deliver an important message. The package of TBTF – too big to fail – measures is not intended to hurt the big banks or the banking sector in Switzer-land. Rather, it aims to protect state and taxpayer from incurring an unwanted and unac-ceptable risk, while also creating the necessary framework conditions for the banking sector to be able to develop sustainably and successfully over the long term.

He gives a nice perspective to the whole idea.

First the Swiss TBTD proposal:

As the above remarks make clear: big, interconnected financial institutions can destabilise the financial system and an entire economy, with dramatic consequences. How can they be made more secure? And how can the problem of the implicit state guarantee be reduced?  The package put together by the Federal Council in Switzerland is precisely targeted at these two questions.

A central component of the Swiss approach is that systemically important banks should markedly improve their capital base and liquidity positions, both qualitatively and quantitatively, and reduce their risk exposure to other banks. Thiswill makesystemicallyimportantbanksmore stable in future and reduce the likelihood of themrunninginto difficulties. Fur-thermore, organisational measures aim to ensure that systemically importantfunctions can continue to be performed during a crisis, whilesimultaneously liquidatingthe big bankin anorderly manner. This reduces the need for state intervention.

These measures may have different starting points and goals, but they all harmonise with each other. If the provisions for improving stability do not suffice and a crisis occurs any-way, the mechanisms that guarantee the continuation of systemically important functions will kick in.In their entirety, these measures helptoensure that the banks are again ableto bearmore of their risks themselves.

The capital regulations are to be progressive. Bigger the zize, higher the capital adequacy and leverage ratios:

The new capital adequacy regulations for systemically important banks are to apply to risk-weighted capital and to the leverage ratio. Furthermore, they are designed to be progressive. In other words, the bigger the bank, the higher the requirement. Given the current size of Switzerland’s two big banks, the requirement would be 19% total capital of the risk-weighted assets, of which 9% can be held in convertible capital (cocos) and 10% must be held in common equity. 

He says people are not happy. But if regualtions lead to higher social benefits it leads to better outcomes:

Firstly, regulation is never free of charge for every participant. However, analysis of the possible costs of regulation must always differentiate between the private and the social costs: in practice, regulation is bound to lead to additional costs for those regulated. This is part of the plan andmakes economic sense provided that these additional costs are smaller than the benefits that regulation brings to the entire economy. If regulation leads to the elimination or re-duction of market distortions – such as subsidies, for example – then an economically more efficient result is obtained.

Secondly, regulation can be formulated in a more or less cost-efficient manner. Particular attention was paid to this element in Switzerland. For instance, the additional capital re-quired here by systemically important banks can largely be held in the form of more cost-efficient convertible capital.

Thirdly, the proposed measures are by no means excessive in scope – on the contrary: the increase in capital would reduce the big banks’ ratio of debt, which currently stands at ap-proximately 98%, by only three percentage points: around 95% of the balance sheet total could continue to be financed by borrowed capital!

He touches on other issues like:

  • Will stricter regulations push up borrowing costs within Switzerland? — no theoretical/empirical evidence suggests so. Short-term may be but long term advantages are huge..
  • Is international competitiveness being weakened? — not really as Swiss banks known for stability. He looks at the international regulations in fiannce and there is a nice table which shows each country has been different. Swiss has been far lenienet than say US and UK.
  • Is the Swiss package of measures being introduced too quickly? Again not true as not right to wait for for international bodies. Lot of homework has gone in before these measures have been implemented.

Superb speech.

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