Understanding The Impact Of Stricter Capital Rules For Swiss Banks

by Trefis Team
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In the last few years, UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) have been making considerable changes to their business models in order to comply with the stringent capital requirements set by Swiss regulators. Swiss regulatory requirements are already the strictest in the world – requiring capital buffers well above those suggested under the already tight Basel III norms – but Swiss legislators seem to believe that the sweeping changes the banks have implemented are still not adequate. While the topic of a complete split between the banks’ investment banking and wealth management operations has been under discussion for quite some time now (see Swiss Lawmakers Debating Motions To Split UBS & Credit Suisse), the latest regulatory hurdle the banks are staring at is a possible hike in the leverage ratio requirement to a level more than three times that which is applicable to banks under Basel III.

Talks about the need for stricter leverage ratios for the Swiss banks are not new, as the Swiss National Bank (SNB) had called for higher leverage ratio requirements this June. [1] But with the Swiss Finance Minister recently detailing her stand on this point by arguing in favor of a leverage ratio between 6% and 10% for the banks, as opposed to the 3% mandated by Basel III norms, the likelihood of legislation being passed to this effect has increased substantially. The Swiss banks bore the brunt of this conclusion early this week, as UBS and Credit Suisse lost 5% and 7% of their share value over trading on Monday – the fall in value readily justified by the fact that higher leverage ratio requirements will force the banks to continue to cut down on capital-incentive operations and will result in a reduction in profitability in the long run.

See our complete analysis of Credit SuisseUBS

Why The Shifting Focus From Common Capital Ratio To Leverage Ratio?

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. 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 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. 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.

What Does A Higher Leverage Ratio Mean For UBS and Credit Suisse?

Swiss regulators have established themselves as being very cautious about the requirements they lay down for the country’s largest banks with their common capital ratio norms, which are the most stringent around the globe. This makes the possibility of their imposing stricter leverage ratio requirements on the banks quite likely. To understand the impact of a rule making it mandatory for the banks to maintain a leverage ratio between 6-10%, it would help to know that UBS reported a leverage ratio of 4.2% for Q3 2013 while Credit Suisse reported a figure of 4.1% (at the bank level). Now to achieve the target leverage ratios, the banks will have to hold back on dividends, issue additional equity (diluting shareholders’ interests) and also shrink its asset base by getting rid of capital-intensive units.

The magnitude of the effort required can be gauged by the fact that assuming they maintain their asset base at current levels, UBS will need to increase its equity by between CHF 19.6 billion to CHF 62.1 billion ($21.3 billion to $68.3 billion) while Credit Suisse will need to increase its equity by between CHF 22.1 billion to CHF 69.5 billion ($24.4 billion to $76.5 billion). Compare this with the net income figures reported by the banks for Q3 2013 – CHF 578 million for UBS and CHF 692 million for Credit Suisse.

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 []
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