Switzerland: UBS-Credit Suisse Takeover Highlights Long-standing Financial-sector Contingency Risk

The last-minute deal, to be completed in coming weeks, should help contain the financial cost of stabilising the pressured Credit Suisse for the Swiss Confederations economy.

The events highlight long-standing contingency risks to the sovereign stemming from the banking system, given its large size relative to the economy and Switzerlands annual budget.

Total assets in the Swiss banking system stood at CHF 3.5trn at the end of 2022, equivalent to 448% of GDP . UBS accounted for 132% of GDP at YE 2022, while the much-reduced balance sheet of Credit Suisse accounted for 69%. Hence, the combined balance sheet of UBS and Credit Suisse amounted to around CHF 1.55trn, or around 200% of GDP. The merger thus results in a greater concentration of contingency risks for Switzerland.

Beyond balance-sheet metrics, the Swiss banking system also contributes significantly to the domestic economy via its contribution to gross value added (GVA, 5.9% of the total on average 2017-2022) and to employment (3.6% in 2022 according to BAK Basel).

Swiss Government Uses Financial Strengths to Full Advantage

The Swiss government has used its financial power to help find a solution to the Credit Suisse crisis by providing a guarantee of CHF 9bn (or around 1.2% of GDP) to UBS to cover potential losses above CHF 5bn from winding down some Credit Suisse positions. In addition, the government has provided a CHF 100bn (13% of GDP) guarantee to the Swiss National Bank (SNB) to provide further liquidity via a newly established Public Liquidity Backstop (PLB) facility, which does not need to be collateralised.

The liquidity provided by the SNB via the PLB benefits from preferred creditor status, which helps mitigate risk to the sovereign. So does the ample capitalisation of Credit Suisse and the write-down of the bank‘s AT1 securities of CHF 16bn, which increases core equity. Should the SNB incur uncovered losses on any of its exposures, this would affect the Confederation and Swiss cantons through SNB annual profit allocations, as was the case when the SNB’s 2022 losses of CHF 133bn prohibited any profit allocation.

The merger is designed to help draw a line under Credit Suisses problems, driven by substantial deposit outflows in the final quarter of 2022, visible in the decline of non-domestic, dollar-denominated deposits in the Swiss banking system .

However, there will be domestic economic consequences. The announced merger is certain to lead to job cuts at Credit Suisse, which employed around 50,000 persons globally and 17,000 in Switzerland, or around 11% of total employment in the banking sector.

The sector‘s contribution to GVA will also suffer. As a point of reference, real GVA from financial services dropped by 11% in 2008 during the Global Financial Crisis, when UBS required State support, and took until 2020 to recover its 2007 level. Finally, given the merged entity’s dominant position in the Swiss banking system, there are risks that competition and efficiency will be adversely affected. According to UBS, the merged entity will be the domestic leader in terms of deposits and loans outstanding.

That said, we acknowledge that Switzerland‘s strengthened regulatory regime has contributed to mitigating even larger contingency risks. FINMA’s too-big-too-fail resolution (TBTF) regime includes additional regulatory requirements for systemic banks. At the same time, the TBTF regime was not fully utilised in this case (which would have included the conversion of bail-in bonds) as the authorities favoured a solution via private players.

In addition, liquidity needs in foreign currency, in particular in dollars, can be covered through dollar auctions of the SNB, now held daily, which can itself mobilise dollars via a standing dollar swap line with the US Federal Reserve and via its foreign-exchange reserves of CHF 801bn at YE 2022, 38% of which were denominated in dollars, acting as a potential second line of defence.

Switzerland has significant shock-absorbing capacity given credit strengths of a very wealthy and well-diversified economy, solid public finances and strong external metrics: public debt stood at a modest 42.1% of GDP at the end of 2021, while real GDP growth was 4.2% in 2021 and 2.1% in 2022.