The Federal Council is expected to present its report on the future regulation of the remaining major banks in the country on Wednesday. The new state liquidity guarantee can be considered a given, but even this instrument is controversial.

The consensus in Bern to let sleeping dogs lie at the crisis-hit Credit Suisse (CS) led to a fateful maneuver in 2022. Instead of quickly bringing the «Public Liquidity Backstop» (PLB), to parliament, as is common abroad to secure the banking system, it was artificially delayed.

That move would backfire. In March 2023, politics was caught up in the CS crisis. The PLB had to be introduced by emergency decree to support the sale of CS to local rival UBS with state-guaranteed billions. Only last October did the Federal Council officially send a message to parliament to finally convert the emergency-born PLB ordinance into proper law.

Nasty Surprises Likely

Since then, negotiations in Bern have been running parallel to the efforts of the Federal Council to revise the "Too big to fail" rules for the remaining Swiss major banks. The government report, eagerly awaited in both politics and the banking industry, could be presented as early as this Wednesday.

The systemically relevant major banks – including the UBS extended by Credit Suisse (CS), the Raiffeisen Group, the Zürcher Kantonalbank (ZKB), and the Post subsidiary Postfinance – may well expect unpleasant surprises. Because Finance Minister Karin Keller-Sutter has promised to prioritize protecting taxpayers in future regulation.

Sergio Ermotti is in Favor

While the industry would likely oppose additional costly equity, it is not averse to the introduction of state liquidity guarantee. The Swiss Bankers Association (SBA) is fundamentally in favor of the PLB, as is UBS CEO Sergio Ermotti, who has repeatedly pointed out that the instrument has been sorely lacking in Switzerland.

So when Federal Councillor Keller-Sutter presents the evaluation of major bank regulation, she should have a relatively easy game. But as it turns out, even this «no brainer» – the PLB is common abroad, successfully deployed as of March 2023, and welcomed in the banking industry itself – is controversial.

This could prove to be a bad omen for the future security of Swiss major banks.

Can UBS Go Downhill?

It has already been shown that the state-guaranteed billion-dollar support is difficult to explain. It is often perceived as at least an implicit state guarantee. The idea of a state guarantee for the «new» UBS has stirred up emotions even among market experts, as was recently demonstrated in an interview with retired finance professor Urs Birchler.

According to the economist, UBS can «go downhill» in credit business thanks to the implicit state guarantee, while many domestic and foreign competitors face an uphill battle.

Banks Cannot Count on PLB

However, this is not the case with the PLB mechanism: There will be no fixed entitlement to state liquidity support. It will only be applied if pre-defined criteria are met – such as the exhaustion of emergency liquidity provided by the Swiss National Bank (SNB).

At that point, one major bank is far from doing well. It can no longer conduct business in the same way and would have to undergo drastic restructuring measures. The latter was spared to CS last year. Instead, it will have merged entirely into UBS by 2026.

Bank Leadership Will Not Go Unscathed

Similarly, in the event of PLB deployment, shareholders and creditors of the affected major bank will not be able to recover without harm. Their claims are subordinate to those of the National Bank and the federal government.

Nor, as promised, would bank leadership escape unscathed. «The deployment is likely to lead to the existing management being removed, held accountable, and financially penalized through the recovery of previously granted variable remuneration,» writes the SBA in a position paper.

Markus Gygax Interferes

Whether critics of the instrument will be swayed is uncertain. They are now found not only in politics but also within the banking industry itself. Markus Gygax, president of the Swiss Regional Banks Association (VSRB), caused quite a stir with a comment last November. With the PLB, discrimination against all smaller banks in Switzerland is looming, he warned.

This is because for customers and shareholders, the sum of the «lines of defense» is relevant – and with the PLB, the major banks have one more defensive line, according to Gygax. Therefore, the representative of regional banks demanded that the existing emergency liquidity assistance provided by the SNB be expanded – or that the PLB be extended to all Swiss banks.

Federal Council Sent Flat Rate into the Race

A similar demand is that Swiss major banks must pre-pay for the provision of a PLB; this has also been included in the federal council's message after the consultation. According to the government's wishes, this «compensation flat rate» should function like an insurance premium and help avoid distortions of competition.

According to estimates, the systemically relevant banks would have to pay a total of CHF 70 million to CHF 210 million annually for the new risk protection into the general federal budget.

The Problem with State Banks

However, the flat rate has again been rejected by the Swiss Bankers Association. Since there is no entitlement to the PLB and substantial interest and premiums would already have to be paid to the federal government in the event of deployment, a compensation flat rate lacks a logically comprehensible justification, criticizes the banking lobby.

So, here lies another point of contention – and not the last one. From the perspective of state institutions among the major banks – ZKB and Postfinance – the federal government's liquidity guarantee is added to an existing state guarantee. In the case of ZKB, the canton of Zurich is liable for its bank, while in the case of Postfinance, the parent company, Swiss Post, is liable.

In the case of ZKB, the question of a flat-rate compensation to the federal government is particularly virulent, as the institute must pay millions to the canton each year to settle the state guarantee.

Double Security Raises Questions

Legal experts at the Institute for Federalism at the University of Freiburg have already addressed this issue. They emphasize that after the introduction of the PLB, in the event of a crisis, ZKB would be subject to both federal liquidity assurance and cantonal state guarantee – which the experts fundamentally question.

«With the new PLB system, the question arises as to what extent the cantonal state guarantee still makes sense in the new PLB system; both pursue partially overlapping objectives and have partially similar design elements,» they write.