Switzerland's central bank is demanding UBS and Credit Suisse build a bigger financial cushion to save a repeat of the subprime mortgage disaster that spoilt the country's reputation as an unshakeable powerhouse.
If the influential central bank gets its way, UBS and Credit Suisse will have to hoard more capital than their anglo-saxon rivals and that would be a millstone around the necks of their investment banks.
The Swiss National Bank laid down its blueprint for a stronger banking system in its annual financial stability report on Thursday.
It highlighted the need for a "higher capital buffer at big banks" given their dominance in Switzerland. "Their size and importance for the Swiss economy justifies especially prudent decision making when determining the level of their capital base," the report said.
The Alpine state is still reeling from the shock of seeing UBS write $37 billion off dud investments — twice that of Royal Bank of Scotland.
Switzerland's Federal Banking Commission, which is ultimately in charge of banking regulation, has also suggested raising capital requirements for the investment banks. UBS, once a rock of Swiss financial prowess, is now Europe's biggest casualty of the global crisis triggered by risky U.S. home loans.
Worse still, there are signs that UBS's prized wealthy clientele are growing nervous. Money flows into the bank's wealth management business slowed to a trickle in the first three months of the year.
This has sent alarm bells ringing in Switzerland, whose economy is highly dependent on banking with the world's rich. Millionnaires from countries such as Germany and Russia take refuge under Switzerland's cloak of banking secrecy.
But that is not the only reason UBS and Credit Suisse are important for Switzerland. Their retail branches dominate the country. They also play a key role in how the Swiss central bank distributes money on the interbank market.
How much capital banks set aside now is determined now by the riskiness of the assets they own, whether they be government bonds, a credit card debt or home loan. The Swiss central bank, however, wants to scrap this rule that allows banks hold less capital for "safe" assets.
The current crisis was sparked when such safe assets turned out not to be unsaleable.
The Swiss now want to raise the bar by introducing a so-called leverage ratio, which would force banks to put more money aside to cover risks.
"The leverage of the Swiss banks is particularly high," the report says. "As the current turmoil has shown, one consequence of high leverage is that losses which are small in comparison to a bank's assets can deplete a significant portion of its capital." (Reuters)