Swiss Banks Likely To Continue Shoring Up Capital As SNB Proposes Higher Leverage Ratio Requirement

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The largest Swiss banks UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) may have to keep working on their balance sheet quality over the next few quarters, as the Swiss National Bank (SNB) is pushing for stricter rules governing their leverage ratio requirements. [1] Swiss regulatory requirements are already the strictest in the world when it comes to core capital ratios, but their leverage ratio requirements are more lax than what are mandated by regulators in the U.K. and U.S.

Talks about the need for stricter leverage ratios for the Swiss banks are not new, as the SNB has been demanding a higher leverage ratio since June 2013. [2] But with the Swiss government currently working on draft legislation covering leverage ratios for systemically relevant banks, the SNB’s stand is bound to be considered. [3] Higher leverage ratio requirements will force the banks to delay their capital return plans. They may also have to get rid of some of their capital-intensive yet profitable units over coming months to comply with the stricter capital requirements.

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The common equity Tier 1 (CET1) capital ratios as defined by the Basel committee have been the de facto standard for comparing the financial health of banks across the world for more than two decades since they were standardized as a part of Basel I norms. And even as a part of the impending Basel III implementation, they remain the primary capital ratio which banks have to achieve by the 2019 deadline. But even as the manner of calculating this figure continues to be refined to address a wide range of concerns, there is one loophole that has caught the attention of regulators in recent years – the ability of banks to tweak their risk-weighed asset bases (albeit to a limited extent), as they are extremely complicated assets to value and involve subjectivity in their valuation. As a counterbalance to this loophole, regulators have begun shifting their focus on leverage ratios. Taken in tandem, the common capital ratio and the leverage ratio give a much clearer picture of a bank’s financial stability, compared to either of them alone.

UBS and Credit Suisse have made considerable changes to their business models since 2012 in order to comply with the stringent capital requirements set by Swiss regulators. But Swiss legislators seem to believe that the sweeping changes the banks have implemented are still not adequate. Swiss regulators have established themselves as being very cautious about the requirements they lay down for the country’s largest banks, and so a hike in leverage ratio requirements later this year will hardly come as a surprise.

(CHF million except % data) UBS Credit Suisse
BIS Basel III Tier 1 capital  33,515 39,564
BIS total exposures  990,548 1,102,728
BIS Basel III leverage ratio 3.4% 3.6%
Assuming constant denominator:
Tier 1 capital shortfall 16,012 15,572
Assuming constant numerator:
Exposure reduction required 320,248 311,448

The table above shows the current BIS Basel III leverage ratio (full-applied basis) figures for UBS and Credit Suisse and also explains what they need to do to achieve a leverage ratio of 5%. As seen, UBS fares slightly worse than Credit Suisse in terms of leverage ratios. The “Tier 1 capital shortfall” represent the amount by which each bank has to increase its Tier 1 capital to increase leverage ratio to 5% while keeping total leverage exposures constant at the level seen in Q1 2015. On the other hand, “Exposure reduction required” is the amount by which they have to reduce their leverage in case they maintain Tier 1 capital at current levels.

Clearly, the banks will adopt a method that includes an increase in Tier 1 capital as well as a reduction in the leverage exposures. This implies a reduction in the size of their balance sheets by offloading more of their capital-intensive units, and a decision to hold back on dividends over subsequent quarters. The banks may also consider the option of issuing additional equity in the near future – diluting shareholders’ interests in them. Thankfully, the two banks have until 2019 to implement these changes.

Holding back on payments as well as issuing fresh equity will have a negative impact on the payout ratios for these banks over coming years. The chart below captures our forecast for Credit Suisse’s dividend payout in the years to come. You can see how slower increase in the payout will impact the bank’s share value by making changes to it.

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Notes:
  1. UBS, Credit Suisse Should Build Up Crisis Buffers, SNB Says, Bloomberg, Jun 18 2015 []
  2. UBS, Credit Suisse Need to Improve Leverage Ratios, SNB Says, Bloomberg, Jun 20 2013 []
  3. Swiss to Tighten Leverage Rules for Big Banks This Year, Bloomberg, Feb 18 2015 []