Switzerland has reached an uncomfortable conclusion: that UBS has become too large for the state to comfortably stand behind. The government’s plan to force the bank to hold roughly $20 billion more in capital is an attempt to close that gap, even at the cost of competitiveness.
That acute "too big to fail" problem is far from theoretical: during the Credit Suisse collapse and UBS takeover, the Swiss state and central bank deployed hundreds of billions in liquidity and guarantees to stabilise the system.
At roughly twice the size of Swiss GDP, UBS’s balance sheet reflects how banking systems are growing beyond the fiscal capacity of the states expected to rescue them.
This is no Swiss anomaly. In China, banking assets exceed three times gross domestic product and operate within a system where the state acts as the ultimate guarantor, as shown by Beijing’s recent $44 billion capital injection into major banks. The distinction between sovereign and banking risk is becoming increasingly blurred.
The greatest financial risk in the world economy is no longer simply bank failure, but the concentration of banking risk on sovereign balance sheets themselves.
Small, open economies have learnt this harsh lesson before. In Iceland, banks grew to many times the size of the economy, far beyond the central bank’s capacity to act as lender of last resort. When they collapsed in 2008, the state could not absorb the shock.
In Ireland, a blanket guarantee for bank creditors forced taxpayers to absorb roughly €64 billion in losses in 2008 – a rescue that overwhelmed the state’s finances and left it bankrupt. When banks outgrow the states expected to support them, private financial risk becomes a public liability.
Consolidation gathers pace
That risk is becoming harder for policymakers to ignore as bank consolidation gathers pace. Global bank mergers and acquisitions more than doubled in value last year, reaching about $190 billion. European cross-border bank mergers are running at their highest levels since the 2008 crisis. For years, the EU has argued that the bloc needs bigger, stronger banks if it is to compete with its far larger US rivals.
Yet its national governments are becoming less comfortable with the implications of scale. In the past year, Italy used its “golden powers” to impose conditions on UniCredit’s takeover of Banco BPM, while Spain stalled BBVA’s merger with Banco Sabadell. Europe wants banking champions large enough to compete globally, but not liabilities large enough to rescue nationally.
For open financial hubs, including those in the Gulf, Switzerland is a warning. Liquidity support and guarantees still sit with the state. The biggest constraint on openness is not the size of the financial sector itself, but whether the sovereign remains credible enough to stabilise a system it only partially controls.
That has important implications for regulation. Policymakers can no longer pretend that global competitiveness matters more than whether the state itself could survive a rescue. When a bank concentrates risks that are systemically important at home, capital rules have to reflect what the sovereign could realistically absorb in a crisis. But without becoming so restrictive that they simply push risk elsewhere.
UBS capital challenge
There is a case for the Swiss Federal Council’s tougher stance on UBS. For all its global reach, the bank remains deeply embedded in the Swiss economy, where its dominance in key lending markets concentrates risk. That causes a domestic exposure regulators cannot ignore, and helps explain why, in the aftermath of the Credit Suisse collapse and UBS takeover, Switzerland is now confronting this problem.
The country enters this debate from a position of fiscal strength, with low public debt and a strong currency. Yet there is a trade-off. By tightening capital requirements, the Swiss authorities risk eroding competitiveness and pushing up pricing, even as they try to reduce the likelihood of future stress.
There is also no clean structural solution. UBS has outgrown its domestic frame, but breaking it up is less straightforward than it sounds. Carving out its wealth management arm from retail banking would do little to reduce balance sheet risk, since most of those assets are held on behalf of clients.
A purely domestic split is more plausible, but it would come at a cost: weaker economies of scale and higher operating expenses, with at least some of that burden likely to be passed on to customers.
Switzerland faces the same dilemma confronting regulators elsewhere: how to contain systemic risk without undermining the competitiveness of its own financial system.
Capital is global. Backstops are national. Switzerland is simply the first advanced economy being forced to regulate for that reality.
