Before the spectacular blow-up of Credit Suisse earlier this year, Switzerland’s other big bank, UBS, had to be rescued in equally remarkable circumstances during the global financial crisis. While reforms since then have made the world’s banking system safer, it is by no means immune from crises.
To paraphrase Oscar Wilde, to lose one bank may be regarded as a misfortune; to lose both looks like carelessness. But that is almost what Switzerland has done.
Many outside Switzerland forget that UBS – the saviour that stepped in to buy Credit Suisse, the country’s other big investment bank, in March 2023 and seemingly stem the recent banking turmoil in Europe – was itself almost a spectacular failure during the global financial crisis of 2007-09.
The circumstances surrounding the two events, 15 years apart, were quite different. But the inherent difficulties faced by regulators attempting to ensure financial stability remain unchanged.
Why did UBS need to be rescued?
UBS is a microcosm of the global financial crisis. In the years before the crisis, UBS set itself the goal of becoming one of the global leaders in investment banking.
Rapid expansion and record profits in 2005 and 2006 were accompanied by a build-up of risk that UBS failed to understand until it was too late. When the subprime mortgage crisis broke out, UBS was the ‘most exposed’ non-US bank to US real estate funds and derivatives markets.
In 2008, the bank made a loss of 20 billion Swiss francs (CHF). This was the largest loss ever recorded by a Swiss company.
A subsequent report by the Swiss authorities was damning. It concluded that UBS ‘did not sufficiently manage, limit and control its subprime mortgage exposure’, and that ‘insufficient attention to the inherent risks related to the balance sheet growth and the over-confidence in the existing risk management and risk control mechanisms appear as significant failures’.
Similar judgements could be levelled against many other banks at the time.
What did the authorities do?
In the month after Lehman Brothers collapsed in September 2008, UBS became unable to access interbank markets and ran out of liquidity.
On 16 October, it was announced that the Swiss government and the country’s central bank, the Swiss National Bank (SNB), would inject over $60 billion into UBS to replenish its capital and to take over illiquid assets in a bad bank referred to as the ‘special stability fund’.
Overall, this strategy proved profitable. The stability fund eventually realised a profit of CHF5 billion while the federal government earned CHF1.2 billion in interest on the loan it gave to UBS.
But despite the eventual profitability of the scheme, public reaction at the time was negative: taxpayer money was at risk in bailing out a failing financial institution.
The SNB has noted that the UBS experience generated ‘strong political momentum’ for tougher banking regulation. It also almost certainly affected the strategy chosen to deal with Credit Suisse nearly 15 years later.
What happened next?
Regulatory standards across the globe were vastly changed and upgraded in the wake of the global financial crisis.
Perhaps the most relevant changes were measures to insulate the economy from the failure of large, interconnected banks. Banks designated ‘systemically important financial institutions’ (SIFIs) faced tougher capital and liquidity requirements. They were also supposed to develop plans so that they can be resolved smoothly in the event of a crisis.
Globally, regulators identified 30 SIFIs in 2022. Credit Suisse was one of them.
Why did it not work for Credit Suisse?
Credit Suisse failed in March 2023 due to a spectacular series of scandals that weakened the bank. These included money laundering, kickbacks, tax evasion, dealing with dictators and jobs-for-business deals in various jurisdictions across Africa, Asia, Europe and North America.
In March, the prospect of yet another scandal and the announcement by a major shareholder that it would not provide further investment led to a run on the bank by depositors and investors already made nervous by turmoil in US markets, notably the failure of Silicon Valley Bank (SVB).
The Swiss authorities seem to have been determined to avoid a repeat of the UBS rescue where taxpayers initially footed the bill. Once it became clear that Credit Suisse was no longer viable, the authorities quickly asked UBS to step in.
Nonetheless, as part of the final deal, UBS gained access to CHF100 billion in liquidity from the SNB and the Swiss government guaranteed losses of up to CHF9 billion (after UBS absorbs the first CHF5 billion).
Such was the lack of appetite for a public bailout, however, that the Swiss finance minister initially claimed that this was a ‘commercial solution’ before later backtracking.
Did the regulations fail?
Evidently, the regulations introduced since the global financial crisis did not operate as intended.
The plans for resolving Credit Suisse – part of the post-crisis measures to deal with SIFIs – were still incomplete and the chief executive of the Swiss financial markets regulator, FINMA, Urban Angehrn stated that implementing them would have had a ‘disastrous impact’ on the country’s financial industry, adding that ‘many other Swiss banks would probably have faced a run on deposits’.
This is worrying 15 years after the global financial crisis.
Nonetheless, the Swiss authorities have noted that the reforms requiring larger capital buffers enabled Credit Suisse to withstand a run on deposits in October 2022. It has also been argued that tougher European regulations since the events of 2007-09 have made the banking system safer and insulted it somewhat against spillovers from the United States.
Was technology to blame?
The recent turmoil has been referred to as the ‘first bank crisis of the Twitter generation’.
Certainly, in the United States, the rapid spread of rumours about problems at a bank, and the speed of withdrawals from those banks, was enabled by social media and the digitalisation of banking.
In the case of Credit Suisse, FINMA pointed to Twitter rumours as a destabilising factor.
Undoubtedly, this creates new challenges for regulators. But the reasons for the recent turmoil – miscalculations of risk and unaccountable bankers – existed long before the invention of smartphones.
While digitalisation may have increased the speed at which a crisis point was reached, it did not generate the underlying weaknesses that caused the turmoil.
Why is regulating banks difficult?
In 2007, Chuck Prince, then chief executive of Citigroup famously declared: ‘As long as the music is playing, you’ve got to get up and dance’. In 2008, the US government agreed a rescue of Citigroup, which was facing massive losses.
The remark demonstrates that banks’ incentives are not aligned with those of regulators or the public. Designations such as SIFIs make explicit something that banks had been gambling on for some time: that there is a public backstop.
Depositors perceive this too. Following the collapse of SVB, big banks in the United States experienced a spike in deposits. This came as customers moved their money from small banks, which they feared might be allowed to fail, to large banks, which they expected would be saved. To stem the flow, the US authorities had to guarantee all deposits in at-risk institutions.
Prince’s comment also shows that there is safety in numbers: shareholders may punish you if you make low returns when the rest of the industry is riding high. Similarly, if you get in financial trouble for risky business practices, it is much better to do so with a lot of your peers. This ‘herd mentality’ means that regulators must sometimes face down the entire industry.
Similar mismatches can occur in a small country, such as Switzerland, with just one or two very large banks. The imbalance in resources when a bank is twice the GDP of a country leaves the regulator at a massive disadvantage.
In the case of Credit Suisse, the authorities argued that the bank ‘had a cultural problem that translated into a lack of accountability’, and that this was very difficult for a regulator to address before a crisis point was reached.
Indeed, a report for the Swiss government by an expert group recommends that FINMA be given additional and more effective instruments, including the ability to intervene in a bank at an earlier stage.
Does regulation involve a trade-off for society?
There is always a tension between regulators and the regulated. In 2018, Fritz Zurbrügg, then vice-chairman of the SNB’s governing board, emphasised both the importance of big bank regulation in Switzerland and the fact that it was designed to be ‘cost-effective’. Clearly there is a trade-off here.
Tougher post-crisis regulation of European banks has made them safer but less profitable.
In the United States, some of the proposed reforms following the global financial crisis have been rolled-back or watered down. The possibility of regulatory competition and arbitrage, and pushback from banks and even the public if credit becomes less freely available, will always tend to work against tougher regulation of the banking sector.
What does the future hold?
The recent turmoil has shown that while financial regulation after 2007-09 may have made the banking system safer, it is not insulated from failures, spillovers and panics. In particular, the problem of how to deal with the failure of large, interconnected banks remains.
Worryingly, big banks have generally become bigger since the global financial crisis. In Switzerland, only one big bank remains. With no other bank even close in size, the buy-out solution will be difficult to repeat should UBS find itself in trouble again. That may put public money on the hook again.
Overall, the failure of Credit Suisse, 15 years after the bailout of UBS, demonstrates the difficulties of regulating banks and ensuring financial and economic stability.
The recent turmoil is a wake-up call and should make politicians and regulators alike think again about the roles of regulators and large interconnected banks.
Where can I find out more?
- The day UBS, the biggest Swiss bank, was saved: swissinfo.ch on the failure of UBS.
- How the Swiss ‘trinity’ forced UBS to save Credit Suisse: the Financial Times on how the buy-out came about.
- Crooks, kleptocrats and crises: a timeline of Credit Suisse scandals: The Guardian lists the various Credit Suisse scandals.
- European banks and the price of safety: The Economist on the trade-offs of a safer banking system.
Who are experts on this question?
- John Turner
- Tobias Straumann
- Patrick Honohan
- Rebecca Stuart