On March 16, 2023, the Federal Council of Switzerland declared an emergency order introducing the Public Liquidity Backstop (PLB)1. In doing so, the Swiss National Bank (SNB) granted a CHF 100 billion loan to Credit Suisse (federal default guaranteed)2. In September of the same year, the Federal Council also presented its (provisional) draft bill concerning the PLB for banks of systemic importance3.
Art. 7 of the Federal Law on Banks and Savings Banks (LB) defines what constitutes a ‘systemic’ bank. According to art. 7 par. 1 of the LB, a bank is systemic if its “failure would significantly damage the Swiss economy and the Swiss financial system” 4. Art. 8 LB specifies the criteria for labeling a bank as systemic, namely size, interconnectivity with the rest of the economy, and how fast its services can be replaced 5. In Switzerland, there are four systemic banks (following the merging of CS and UBS): UBS, PostFinance, Raiffeisen Group, and the Cantonal Bank of Zurich 6.
Systemic banks are under tighter regulatory control, especially regarding capital requirements and liquidity 7. However, despite such stricter rules—as the CS case so vividly illustrated—systemic banks can also find themselves in stormy seas. When that happens, Swiss policymakers have implemented increasingly invasive measures to restore the bank’s financial health. Back in the day, central banks were said to be the ultimate backstop, as they provided the liquidity to keep the boat afloat. They were called the “lender of last resort”. The recently adopted PLB system ranked the central bank loan as the penultimate resource (for systemic banks) with the PLB being the very last backstop.
The PLB is triggered when:
- the bank’s liquidity is insufficient,
- the central bank has already injected the bank with liquidity, and it can no longer keep it up, given the bank’s collateral 8.
According to the provisional dispatch of the Federal Council, the conditions for the release of said lifeline include that:
- there is no other option, meaning that the bank in distress cannot obtain funds from the market or the SNB;
- the market watchdog, FINMA, is about or has already started the procedure for rescuing the bank,
- the bank in distress has sufficient capital;
- the intervention of the government is needed and adequate to the situation (proportionality) 9.
It is important to stress that, according to the (provisional) dispatch, there is no right to obtain such help from the Confederation: if the conditions are met, the Confederation can (but does not have to) intervene 10.
If there is a green light from the Confederation, the PLB can be issued. This means that the SNB can provide (systemic) banks in distress with liquidity under a guarantee issued by the Confederation 11. The Confederation will enjoy a privilege in terms of credit ranking if the bank goes belly up 12. The Swiss Bankruptcy legislation ranks the creditors into three classes (cf. art. 219 Swiss Bankruptcy Act), which de facto are four. According to the draft bill, the Confederation will be at the top of the list of creditors to pay back. Moreover, the Confederation (and the BNS) will enjoy a risk premium for providing the lifeline 13.
More importantly, the systemic banks must provide financial support ex-ante (a lump sum payment) 14. This idea is coded in art. 32c of the proposal for a revision of the LB 15. According to art. 32c of the revision proposal of the LB, systemic banks provide a one-time sum to the Confederation for covering its risk (art. 32c par. 1 proposal LB). Stated differently, all of the country’s systemic banks must contribute to a ‘whip-round’ in the event one of them is in distress and needs a PLB. Under the PLB regime, a bank cannot pay dividends, and its remuneration policy is restricted under Art 10a LB 16. These measures are intended to limit the moral hazard issue 17. Moral hazard, to be succinct, arises when someone benefits from the negative effect of their actions and decisions.
In particular, under art. 10a LB, a bank that is in distress and needs the help of the Confederation, is no longer free to decide its own remuneration policy (par. 1). The Federal Council can i) limit or exclude variable remuneration (remuneration that is performance-based, i.e., bonuses) and ii) revise the remuneration (art. 10a par. 2 LB) of executives. Finally, systemic banks must introduce a clause in executives’ contracts that retroactively changes their remuneration if their banking establishment receives a bailout (art. 10a par. 3 LB).
It is quite fair to expect that shareholders would not receive dividends if the company is being rescued by the government. As non-systemic banks do not benefit from such a safety net, it also seems fair that systemic banks are the ones that put the money on the table upfront. Finally, incentive matters: if you are a manager who works for a systemic bank, you should be discouraged from taking extra risks.
The problem is that what common sense tells us to be “good” doesn’t always coincide with what economic efficiency considers “good”. Economic analysis of law, long neglected in countries governed by Civil Law, might reveal some unpleasant surprises…
So what’s the verdict on this latest effort to shore up the Swiss financial sector in the wake of the Credit Suisse/UBS merger? In a subsequent article, Dr. Bianchi will offer his take on the pros and cons of the PLB and the future of the Swiss banking landscape.
References
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