October 14, 2010
In the depths of the financial crisis two years ago, Philipp M. Hildebrand, chairman of the governing board of the Swiss central bank, was worried. For centuries, his country had prospered in large part because of its financial sector, and suddenly it seemed possible that sector could cause the Swiss economy to implode.
The country’s two largest banks, Credit Suisse and UBS, had rapidly expanded their balance sheets with risky mortgage-related assets; so much that, combined, they equaled about 7.5 times Swiss gross domestic product in 2008. This was not just a matter of institutions being too big to be allowed to fail, but a case of whether the country had the resources to prevent a failure if many things went wrong.
Unlike the government reaction to troubled banks in the U.S., Swiss authorities forced the two big banks to absorb losses, shrink their balance sheets and raise more capital, and today they are on a much sounder footing. Still, it should be no surprise that Hildebrand and his colleagues are moving more rapidly than most other regulators to try to make sure large banks operating internationally can’t again threaten the global financial system.
Last weekend in Washington, Hildebrand told the annual meeting of the Institute of International Finance, a private bankers’ group, that within two weeks a committee will report to the Swiss government what steps need to be taken in that country to deal with the issue of too-big-to-fail. The starting point, he said, will be the recent agreement on new rules hammered out in negotiations in the Basel Committee on Bank Supervision covering how much capital banks should have on hand to cover losses.
Those rules, known as Basel III, “did not address too-big-to-fail,” Hildebrand said, suggesting there may be more regulation needed. The notion of higher capital requirements, tighter rules and more stringent supervision has executives of the two dozen or so big, international institutions decidedly on edge. If additional restrictions and requirements are too onerous, they could limit the availability of credit or raise its cost to the point that it hurts economic growth significantly, a number of bankers said.
“We are concerned that various authorities are embarking on unilateral actions on the forms that regulation takes and the ways in which it is implemented,” to the point it could “damage the course of economic recovery and growth,” Josef Ackermann, chairman of the IIF board and a senior executive at Deutsche Bank, a German bank on the list of important institutions, said in a press conference.
Basel III: Just a Start
Peter Sands, group chief executive of Standard Chartered Bank, a big British institution, said some government officials seem to view the Basel agreements as just a start; that the timetable for adding to banks’ capital may be compressed and “there will be all manner of additional costly requirements.” Measures being discussed, he said, include additional taxes and levies and a requirement that banks issue a type of debt that turns into equity, which thus wouldn’t have to be repaid if a bank loses a large amount of money.
All are under consideration in Switzerland, Britain, and according to Janet L. Yellen, the new vice chairman of the Federal Reserve, also in the U.S. The recently enacted Dodd-Frank financial reform legislation leaves it to the Fed and other regulators to set many of the rules needed to make it less likely that big institutions will fail. It won’t be easy, but in a speech this week in Denver, Yellen laid out an aggressive agenda for the attempt.
“First, we must understand the sources of systemic risk and design surveillance practices that enable us to detect threats to financial stability early on.” Yellen said. “Second, we must develop a toolkit of supervisory policy instruments … and guidelines on how and when to deploy them. And third, we must strive to avoid situations in which [supervision] and monetary policies are working at cross-purposes.”
Yellen said new policies will require banks to hold more and higher-quality capital, and there have to be new rules to limit the excessive use of credit and leverage. They may have to “build capital buffers in good times,” she said, which would limit credit growth during booms and mitigate credit contraction in downturns. And there should be debt that is convertible to equity if there are significant losses, she said.
A broad approach to dealing with too-big-to fail banks was endorsed in a report released over the weekend by the Group of Thirty, which has representatives from the public and private sectors and academia. It was prepared by a working group headed by Roger W. Ferguson Jr., a former Fed vice chairman and president of TIAA-CREF, who said supervision of individual institutions isn’t enough. “As we have seen, a focus on individual institutions and markets, absent a system view, cannot ensure financial stability and resilience,” he said.
Paul Tucker, deputy governor of the Bank of England and a member of the working group, said, “Authorities must in the future have the tools to require enhancements in the resilience of our capital markets and banking systems as they evolve. And they need to be equipped to lean against stability-threatening exuberance in financial cycles.”
The hardest task will be figuring out what to do if an important institution fails despite all the new rules. Regulators in each country will try to protect their citizens from losses. A comprehensive international agreement can be difficult to negotiate. The pending struggle between regulators and the regulated largest institutions is just beginning.