Swiss Regulator Wants UBS, Credit Suisse To Continue Working On Capital Ratios

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The amount of effort the two largest Swiss banks UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) have put in over the recent years to shore up their balance sheet is no secret with both banks overlooking the short-term performance of their business units for quite a few quarters in the recent past to ensure compliance with stringent capital requirements mandated by Swiss regulators. After all, Swiss regulatory requirements for the country’s biggest banks are the strictest among those imposed by financial regulators around the globe. Thankfully, all the hard work the banks have put in shows in the fact that they are currently among the world’s best capitalized banks, and are well on their way to fulfill the fully-applied Basel III capital requirements slated for 2019, as early as next year.

So UBS and Credit Suisse should be able to weather another economic downturn without any problem, right? But, the Swiss National Bank (SNB) thinks that the answer to this question is still a NO. [1] According to the SNB, the banks may score high on the capital ratios front, but they still need to work on their leverage ratios – a directive that will likely result in the Swiss banks going through yet another phase of focused capital strengthening. This would mean that the banks will tighten their purse-strings further over the coming months, when it comes to handing out dividends.

More importantly, the SNB’s stand in the matter will also rub-off on U.S. regulators who are contemplating stricter leverage ratio requirements for the country’s biggest banks. [2]

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The Tier I common 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. Then what is the need for all this fuss about leverage ratios?

The process of determining which assets count towards Tier I capital and how the total assets are adjusted for risk has undergone considerable refinement in subsequent iterations of the Basel norms. But there still remains one concern among regulators about the Tier I common capital ratio – the ability of banks to tweak around with the risk-weighed asset base (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 over recent months – with the simple leverage ratio figuring high on regulators’ minds as a mandatory requirement for the banking giants. 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.

To gear up on their leverage ratios as directed by the SNB, the Swiss banks will definitely hold back on dividends over coming quarters. The banks may also go ahead with additional equity issuances in the near future, diluting shareholders interests in them. The chart below captures our forecast for UBS’s dividend payout in the years to come. You can see how slower increase in the payout will impact UBS’s share value by making changes to it.

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Notes:
  1. UBS, Credit Suisse Need to Improve Leverage Ratios, SNB Says, Bloomberg, Jun 20 2013 []
  2. U.S. Weighs Doubling Leverage Standard for Biggest Banks, Bloomberg, Jun 21 2013 []
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