Hildebrand urges crackdown on 'too big to fail' banks

Speaking at the University of Geneva on Wednesday evening, Hildebrand, who is currently vice chair of the SNB, said “going forward, the world of finance will not be the same anymore". Positive comments on the economic recovery were interspersed with concerns about the Swiss banking system.

“A year ago we were in the midst of a perfect financial storm,” said Hildebrand. But, “we are no longer staring into the abyss of financial and, potentially, economic chaos.”

However his speech was loaded with warnings for Swiss finance – “given the size and importance of our banking sector, our country is particularly vulnerable to a financial shock” – and in particular for heavyweight financials, UBS and Credit Suisse.

Government stimulus measures have had the required short term effect on economic recovery, although these have cost 20 per cent of the gross domestic product (GDP) of the G7 and four other major economies. Ultimately, citizens pay the cost of government intervention, he warned, before outlining policy and regulatory measures.

Increasing the amount and quality of capital and exercising more discipline in retaining earnings are two new obligations on banks. Measures announced by FINMA, the Swiss banking regulator – which works closely with the SNB – on liquidity requirements will take effect in spring 2010.

With markets picking up and the public losing interest in the complicated details of the crisis, Hildebrand is concerned that “the momentum for reform appears to have slowed.” Arms-length supervision is no longer an option and tougher regulation is particularly important in Switzerland, warned the central banker.

The Swiss banking sector plays an unusually large role in the national economy, holding assets worth more than seven times the country’s GDP. Credit Suisse and UBS have a market share of more than two thirds. This means that “here in Switzerland, the problem of 'too big to fail' is particularly pronounced,” said Hildebrand.

The SNB wants a financial system which will not fall apart if big banks fail. The system of the future “must expose financial institutions of all sizes and structures to the ultimate test of the market place,” according to the speaker’s prepared remarks.

A number of banks throughout the world have been cast as semi-nationalised after receiving state funds to help them survive. UBS received 6 billion francs from the Swiss government in 2008 and the central bank created a facility to absorb distressed assets.

But Hildebrand urged international leaders to work together to ensure cross-border institutions can be wound up in the event of future systemic collapses. “Punishing failure” is one of the most basic mechanisms of a market economy according to the liberal market-thinking Hildebrand, who quoted economist Milton Friedman during his speech: “there’s no such thing as a free lunch,” he said, warning that, inevitably, the cost of further regulation will be felt hardest by the banks.

He also described as “striking” the way in which many banks receiving public support paid out more in dividends and share buybacks during the years preceding the crisis than they subsequently faced in losses.

The Geneva audience of academics, press and business executives asked questions – screened by a moderator – about the potential break-up of banks to help reduce systemic risk.

Hildebrand has the technical intellect of a regulator, but the confidence and suave manner of a banker, leaning nonchalantly against a lectern whilst delivering answers. He gestured support for the integrated bank model which allows one area of a bank to support another which is struggling to generate profits.

But in other major financial centres, such as the US and the UK, policy makers have debated whether separating a bank’s retail operations from investment and trading operations – the “casino” departments – might minimise impact of systemic failure in the financial markets on the consumer.

The impression from the conference is that no measures should be ruled out in order to protect the tax payer from having to sure up companies in the event of future crises. Furthermore, the authorities must not “fall prey to lobbying” by business now the worst of the crisis is behind us, urged Hildebrand. In fact, “politicians need to become acquainted with and get involved in this matter. The sooner, the better,” he added.

Looking ahead, the SNB advises Swiss banks to talk about their strong capital position to obtain competitive advantage in global markets. Credit Suisse had a Tier 1 ratio of 16.4 per cent at the end of September, making it one of the best capitalised banks in the world.

In other areas, the SNB is particularly keen to improve settlement and clearing in derivatives markets and ensure more trading is cleared through financially sound central counterparties. The debate over how to reform derivatives – which are used by commodity producers and transporters to manage risk, as well as by speculators guessing the direction of the market – will continue to interest Swiss banks and commodity traders.