Switzerland has taken the sensible move of recognizing that it cannot credibly backstop banks whose assets are more than eight times the country’s GDP. It is in the process of imposing much tougher capital requirements, expected to be nearly 20% of risk-weighted assets, well above the Basel III level of 7%.
UBS apparently plans to partition the bank in a Glass-Steagall lite split, leaving the traditional banking operations in Switzerland and putting the investment bank in a separate legal entity outside Switzerland. This resembles the approach advocated in the preliminary draft of the UK’s Independent Banking Commission report, of having retail banking and commercial banking separately capitalized.
The problem is that the devil lies in the details. Regulators need to be scrupulous that there is no lending or guarantees between the two units, or even cross promotion which may create liability. Recall that auction rate securities, a capital markets product, were sold as an alternative to money market funds. Regulators would need to bar this type of cross marketing if they were serious about separating the entities from a risk assumption standpoint. And if they really were THAT separate, why are they under the same roof? Managerially, it’s hard to manage such disparate businesses, particularly if you end the offsetting benefit of cheaper funding (well, there is one reason they will probably keep the companies combined: executive level pay in banking is very highly correlated with the size of the balance sheet).
The Wall Street Journal questions whether this finesse will work:
Under UBS’s planned overhaul, the investment bank would be transformed into its own legal entity, according to the people familiar with the matter. Swiss regulators hope that the change would mean that if the investment bank encountered problems, the parent company, which also includes a large wealth management arm, would no longer be liable for the losses. Right now, the bank’s units abroad have less capital than they otherwise would need because UBS has agreed to serve as a financial backstop, promising to bail them out if they ran into trouble, these people said.
However, it is unclear whether creating a legally and financially independent investment-banking vehicle will truly insulate the UBS parent company—or the Swiss government—in the event of another disastrous crisis. Local regulators could still demand that the Swiss government step in to cover any future losses at the investment bank….They haven’t decided where to locate the investment-banking entity or how to structure it.
Yves here. I recall well when Swiss Bank Corporation (the company that was dominant in the SBC-UBS merger despite the survival of the UBS name) decided to transform itself into a major capital markets player by investing in and later acquiring a client of mine, the cutting edge derivatives firm O’Connor & Associates. O’Connor had decided it needed access to a much bigger balance sheet in order to remain competitive. The European universal banks have tremendous funding cost advantages; US players in the 1990s would often contend that they needed to have a similar degree of integration to hold their ground. So query whether this arrangement will be economically viable continued cross subsidies between the two entities that vitiate the structural separation.
And of course, let us look at the intent. Whether or not the UBS scheme works, the objective is to move the risk of the investment banking operations to somewhere outside Switzerland. All the US investment banks needed to be rescued in the crisis (spare me the “Goldman was sound” palaver. And pretty much no one save a few loyal defenders of the Administration believes that the Dodd Frank Title II resolution authority will work for a meaningful capital markets firm. If you had told most financial professionals in 2006 that a crippled investment bank would be rescued by the government, they would have told you you were nuts. We now know better. So why should the US (or the UK) voluntarily take on risky operations that they may have to backstop? (One could cynically say this is a moot issue, given that the Fed lent money generously to foreign banks in the crisis).
The WSJ article voices some similar doubts:
Part of that calculus appears to hinge on where the investment bank would enjoy the greatest latitude to operate, although Swiss regulators want the unit headquartered in a country where the investment bank has major operations…
Under its current setup, the Swiss parent company has agreed to serve as a financial backstop for the world-wide operations of UBS’s investment bank if they encounter problems. As a result of those guarantees, local regulators in various countries permit the units to operate with thinner capital cushions than they would otherwise need to maintain.
Better insulating UBS’s investment bank from other operations could make it difficult, or at least costlier, for its bankers to use the company’s vast balance sheet to win deals, according to people familiar with the matter. Currently, the investment bank is able to use the heft of the balance sheet of the entire firm to borrow against to participate in deals. That financing capability would be reduced if the investment bank was isolated from the rest of the company and its balance sheet was smaller.
The UBS CEO complained that the Swiss rules will increase their cost of doing business. That is a feature, not a bug. Effective insurance is not free.
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The idea that any of these mega banks will ever be constrained by law is ludicrous. In the next crash they will all be draining the Fed and the ECB, while everything and everybody which is not a bank or a corporate behemuth will be rooting in the rubble. Just how a sensible person makes plans in this environment is the question about which we should all be thinking.
Yves,
Do you think all of this is just posturing by UBS to get the Swiss government to lower the capital requirements to Basel III levels?
Richard
At the risk of preempting Yves, YES!
Also, the derivative exposure the spun-out UBS Investment Bank would carry with it constitutes a portable tactical nuclear weapon. Wherever the bank locates, the “counter-party” threat to the system remains.
I expect many more years of regulatory arbitrage like this UBS effort. Why don’t they just move it all to Connecticut? The politicians here in the US never mess with banks. They could run at 30-1 leverage here on the trading book and no one would bat an eyelash.
No, I don’t think this is posturing. The SNB was furious at having to bail out UBS. They were the only bank regulator in the world to make a bailed out bank hire an independent party and produce a report explaining how it blew itself up.
The SNB knows that the big deposit business, namely private banking, will stay in Switzerland. They’d be delighted to see the risky operations domiciled elsewhere.
UBS = Union Bank of Singapore
This is a sensible move for Switzerland.
“So why should the US (or the UK) voluntarily take on risky operations that they may have to backstop?”
The “they” is us little taxpayer folk Yves. We involuntarily assumed the risk in 2008. To disallow UBS is admitting this risk assumption.
Likely a key domicile consideration are the associated political contributions.
The Swiss appear to be determined not to suffer the fate of the Irish and become paupers because they foolishly assumed the debt of their banks. Whether the creation of separate legal entities also creates two economically independent entities as yet to be seen. The rats nest of financial obligations that was exposed by the Lehman collapse still exists and that defies simple solutions.
The takedown of Strauss-Kahn signals the end of the bailout policy for European markets. A Glass-Steagall partition is the only way banks can survive the oncoming “correction” that will wipe out their investment firms. UBS knows this, and is acting accordingly. If you want the real picture on this, watch this video: http://www.larouchepac.com/dsk
So is it likely that UBS Commercial Banc will, as a separate legal entity, move its risky operations to a country outside Switzerland that has a LARGE TAX BASE? Will this require a referendum of the citizens of that country? May I suggest they move to China.
Maybe they’re just preparing for a Greek default. Move all the Greek loans into the ‘bad bank’, and send it off to the USA — keep all the good stuff in the good bank. After the ‘not a default’ the USA ends up holding the bag.
Glass-Steagall is growing in support in the US since DSK’s “Don Giovanni” statue moment . See here more detail. http://larouchepac.com/node/18273
Looks like another shot across the bow in resistance to further bailout of hopelessly insolvent enterprises, this one aimed at Bernanke and Geithner, following the opening salvo hitting DSK (a.k.a. “Jacques the Raper”)…
Since the US Government has an appetite for destruction, mostly of others, let us expand The Fed’s Hegemony of Systemic Financial Quantitative Easing, commensurate with the New American Century Military Hegemony Statement of Principles:
we need to accept responsibility for America’s unique role in preserving and extending an international order friendly to our security, our prosperity, and our principles.
So yea, send us your periodic crisis prone financial enterprise, as the reserve currency of the world, we’ll deal with it.
The European project depends on giving Europarl, the European Parliament, full power, and taking that power away from the Council, the Commision, the ECB, and all the other unaccountable bureacracies.
Europarl is structured to be about as responsive as we know how to make a legislature. Yet it has little real power.
Yves,
A look at the time of the expansion of the balance sheets of UBS and CS during 1995-2007 shows that there is no positive relationship between balance size and employment of big banks domestically.
This suggests that there is (either theoretically or empirically) no evidence indicating that the Swiss economy will be negatively affected by the proposed new Swiss Rule.
Even after the proposed new regulations roughly 95% of total assets may be financed by debt. To date approximately 98% of debt financing was possible.
I have in addition also a few charts
Here is the link:
http://acemaxx-analytics-dispinar.blogspot.com/2011/05/das-too-big-to-fail-projekt-der-schweiz.html
It is time for the banksters to pay the piper and in full measure. Let’s stop the shilly-shallying. We need to tell our fracking politicians that WE KNOW WHAT THEY HAVE BEEN UP TO AND HOW STUPIDLY THAT THEY HAVE BEHAVED. We need to let them know that we will forgive them if they:
REINSTATE GLASS STEGALL—ALL OF IT. NO LITTLE FIXES INTENDED TO SATISFY EVERYBODY. Banks need to be re-regulated and they need to be taken out of the roulette wheel of high finance.
DERIVATIVES BASED UPON REAL ESTATE AND DEBTS NEED TO BE OUTLAWED. They incent the wrong behaviors all the way down the line and they are bad news.
We need an amendment to the Constitution that outlaws the outrageous Supreme Court decision that lets big companies buy candidates
The Goldman SACKS connection to the government must be dissolved permanently as must all the other ridiculous connections that have created the fascist state that we now have.
9/11 MUST BE FULLY INVESTIGATED AS WELL AS WHAT REALLY HAPPENED DURING BOTH THE 2000 AND 2004 ELECTIONS.
ALL ELECTRONIC VOTING MACHINES MUST BE DISCARDED. WE NEED TO RETURN TO PAPER to stop the election rigging. YES, GENTLEMEN, THEY ARE STEALING THE VOTES AND IT IS NOT THE POOR PEOPLE DOING IT. THAT IS ABSURD. IT IS THE RICH WHO NOT ONLY RIG THE ELECTIONS, BUT BUY THE MACHINES TO DO IT FROM THEIR CRONY FELON FRIENDS.
If we have to, let’s get the Swiss company that guarrantees honest elections to come in. They use serialized colored paper ballots and they aren’t to be bought.
I am sick of all of this mess. DHS MUST BE DEFUNDED BECAUSE IT WAS THE PRODUCT OF A CRIMINAL CONSPIRACY TO TAKE THIS COUNTRY OVER.
TSA MUST BE DEFUNDED. HOW DARE THEY THREATEN STATES WITH SHUTTING DOWN THEIR AIR TRAFFIC? THAT IS NOT THEIR JOB.
IT MUST BECOME ILLEGAL TO ATTEND BILDERBERGERS, TRILATERALS, CFR, MEETINGS AT CHATHAM HOUSE OR TRAINING AT TAVISTOCK. NOBODY IN OUR GOVERNMENT OR INDUSTRY SHOULD BE AT THESE MEETINGS WHERE THESE IDIOTS ARE PLOTTING THE OVERTHROW OF OUR GOVERNMENTS AND PUTTING THEMSELVES IN POSITIONS OF UNCONTESTED POWER.
THEN ALL THE FREE TRADE PORNOGRAPHY MUST BE STOPPED. Not only is it unwise to try to divide the world into those that make things and those that don’t or to try to drive wages down to the point that people cannot survive on them…if there were a crisis of any magnitude, countries without manufacturing capability would be up a creek without a paddle. Not to mention the wastefulness of carting things to one place to make stuff and then wasting more fuel to send them elsewhere.
I could say a great deal more but I won’t.