Banks too big to fail, but not to jail

Credit Suisse could face the full weight of US law Keystone

The threat of imminent United States criminal charges hanging over Credit Suisse has further highlighted the danger to Switzerland’s economy of one of the country’s big banks going bust.

On Monday, US Attorney General Eric Holder said no company was “too big to jail” and pledged to pursue any institution that breaks US laws. His comments sparked rumours that he was specifically referring to Credit Suisse, which is under investigation for alleged tax evasion offences.

It has emerged that the bank has adapted its “too big to fail” strategy to deflect any damage arising from criminal charges away from the group as a whole. A special holding company, CS International Advisors, was set up last December to house all US client accounts that fall under the investigation.

“Under this construct, the group and its parent company would be responsible for paying fines, but the new subsidiary might bear the weight of any criminal indictment,” Peter V Kunz, an expert in international corporate law at the University of Bern, told swissinfo.ch.

“This is important because the US, in all likelihood, could not tolerate any Credit Suisse subsidiaries operating in the US if the parent company has been issued with a criminal indictment.”

CS International Advisors may have been created by the bank as a sacrificial lamb for the US Department of Justice, speculated Kunz.

“In addition to issuing stiff financial penalties, the DoJ needs a symbolic scalp to show that they are being tough,” Kunz said. “Credit Suisse is dangling just such a trophy in front of them.”

In short, the holding company resembles a hastily constructed garden shed at the end of the garden designed to be obliterated by a storm while protecting the main building.

Banks act

Six years on from the financial crisis and seven from the first rumblings of the transatlantic tax evasion row, Switzerland’s biggest banks are still struggling to re-engineer themselves into fitter enterprises, better equipped to deal with such blows.

Driven on by demanding regulators, UBS and Credit Suisse have shown no lack of effort or will to shed billions of francs worth of risky assets and substantially swell loss absorbing capital reserves.

For example, after the 2011 rogue trading scandal, UBS slashed its investment banking business and vowed to halve the CHF300 billion of risky assets that were sitting on its books by 2016.

But both are still deemed too big to fail, and as such, pose too big a threat to the country’s economy.

It is easy to understand why neither institution, along with Zurich Cantonal Bank (ZKB) – the other systemically relevant institution – could be allowed to go bust.

What is too big to fail?

So-called systemically relevant banks are those that are deemed so large and offer such vital financial services to the population that their collapse would cause major problems for the rest of the economy.

Such vital services include retail deposit and savings accounts, mortgage loans and lines of credit to companies – the finance that greases the wheels of business and households.

When a financial institution has captured a large share of this domestic market, its bankruptcy could cause chaos.

Governments and regulators also take into account the number of people who are employed domestically by such banks. The prospect of tens of thousands of workers losing their jobs all at once is hard to stomach.

Then there is the value that these institutions add to the domestic economy as a whole to be taken into consideration. Profits generated by services offered by banks add up to a large chunk of the gross domestic product whilst, in normal times, corporations and their employees contribute a large slice of taxes.

UBS and Credit Suisse were named as ‘too big to fail’ banks from the onset, but ZKB was added to the list by the Swiss National Bank in November, 2013.

On May 7, Finma released estimates of how much capital reserves UBS Credit Suisse will have to set aside (capital ratios) by 2019, when too big to fail laws fully come into effect, and how much of their own trading can be financed by debt (leverage ratio).

Based on the current state of the banks’ books, UBS would have a minimum capital ratio of 19.2% and a leverage ratio of 4.6% while the smaller Credit Suisse would be set a capital ratio of 16.7% and a leverage ratio of 4%.

However, Finma stressed that the estimates are likely to change as the banks continue to shed risk.

Worth to the economy

UBS claims to reach one in three Swiss households with retail accounts, mortgage loans and other credit. More than 40% of all Swiss businesses and one in three pension funds use the services of Switzerland’s largest bank.

Credit Suisse has 1.8 million domestic clients spread among its retail, asset management and wealth management businesses. It also has CHF95 billion ($108 billion) share of residential mortgage loans on its books out of a total of around CHF690 billion across all Swiss banks.

ZKB claims to have cornered between 6-8% of the household loans market with almost CHF70 billion in outstanding residential mortgages. Between them, all three banks currently employ more than 50,000 people in Switzerland while supporting many other jobs indirectly.

Just before the financial crisis struck, the combined balance sheets of UBS and Credit Suisse were six times larger than Switzerland’s entire economic output. That ratio has now shrunk to two and a half times gross domestic product, but the loss of just one bank would still leave a large hole in Switzerland’s economy.

New plumbing

In addition to shedding risk and bulking up capital reserves, the two largest banks have also been moving to reorganise their group structures.

While exact details are thin on the ground, the driving force is to bundle vital Swiss services in holding companies based in Switzerland and house riskier investment banking and US wealth management businesses under different legal constructs in Britain and the US.

The theory is that each holding company could be liquidated without affecting the others in the event of a catastrophe. The banks also hope that the Swiss Financial Market Supervisory Authority (Finma), the country’s regulator, will be impressed enough to ease up on capital requirement demands.

But Finma is so far playing hard to get, only saying that each bank has to jump through yet more (unspecified) hoops to qualify for such relief.

“The fact that a bank has created a new holding structure does not automatically result in minimum capital requirements relief,” Finma spokesman Vinzenz Mathys told swissinfo.ch. “Holding structures could count as one measure that addresses resolution and recovery requirements under too big to fail regulations, but a range of other measures also need to be fulfilled.”

ZKB, the smallest of the ‘too big to fail’ banks, does not anticipate having to change its structure as it has fewer international operations. Like Credit Suisse, ZKB is under active criminal investigation in the US for alleged tax evasion offences, but the cantonal bank is keeping its legal strategy to itself.