Monday, October 4, 2010

Switzerland Says Basel Isn't Enough

. Monday, October 4, 2010

Swiss regulators will require their largest banks (UBS and Credit Suisse) to hold more capital than the Basel minimum:

The rules, which require approval by the Swiss parliament, address concerns by the Swiss National Bank and others that a severe crisis at Credit Suisse or UBS could prove more than the nation of 7.8 million people could bear. The two banks’ combined balance sheets are five times the size of the Swiss economy.

“Given their size, it cannot be ruled out that the big Swiss banks are potentially T.B.T.B.R.,” or too big to be rescued, the Commission of Experts said in a report. The commission, which was appointed by the Swiss Federal Council, included representatives of the central bank as well as industry and the two big banks.

Credit Suisse and UBS said in statements that they will be able to meet the requirements, which by the end of 2018 would require them to maintain low-risk reserves equal to 10 percent of their total assets. That is a higher reserve requirement than was proposed for global banks last month by the Basel Committee on Bank Supervision.


This follows the historical pattern of some states enacting stricter regulations at the domestic level than the international agreement requires. The question is why? After all, won't this put UBS and Credit Suisse at a competitive disadvantage in globalized capital markets?

Maybe, but notice this part of the article:

The rules would require the two big Swiss banks to hold so-called common equity, the most durable form of capital, equal to 10 percent of their risk-weighted assets, or assets whose value has been adjusted according to how risky they are. The more reserves a bank has, the more it is able to absorb losses if the value of its holdings declines or its customers cannot repay loans.


Emphasis added. Why is this important? Because banks that are better able to absorb losses are less likely to fail, it is less risky to do business with them. As a result, those banks are able to attract funds at lower interest rates. This is even more true for larger banks that can benefit from scale.

A bank can increase profits in two ways: lending more at any given interest rate spread, or lending at a higher spread. We generally think of regulation as intending to prevent a race-to-the-bottom in the former, but some regulations may also target the latter. It's a running theory of mine (that I hope to be able to research more thoroughly in the future) that governments can thus provide competitive advantages to their firms by enacting stricter regulations, as this sends a signal to markets that their firms are safe investments, which lowers their borrowing costs and increases the interest rate spread.

I'm not yet sure what the full implications are, but I think that we should probably expect to see states competing over regulatory policy along a number of dimensions, and not just a race-to-the-bottom. This move by Switzerland may be evidence of that.

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Switzerland Says Basel Isn't Enough
 
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