TBTF: Do Increased Capital Requirements, Bail-In Powers And Resolution Authority Solve The Problem?

Author:Dr. Rashid Bahar
Profession:Baer & Karrer

In the wake of the financial crisis of 2008, governments across the world decided that it was time to end the bail-out of too-big-to-fail financial institutions. This article considers the strategies deployed in Switzerland to solve the problem: increased capital requirements, including leverage ratios and liquidity requirements, funding of the resolution in the event of a gone-concern, resolution measures, through bail-in powers and the authority to transfer assets, liabilities and live agreements to another financial institution, as well as the resolution stay, and finally, organizational measures, which were not imposed through rules, but rather implemented through a carrot-and-stick approach using positive incentives and regulatory sanctions, to nudge financial institutions to improve their resolvability. In conclusion, we take stock by looking back at what was achieved, but also consider the risks that come with the increased powers granted to regulators and supervisory authorities following the crisis.

  1. Looking back: from bail-outs to bail-ins

  1. Bailing out UBS AG

    Ten years ago, on 16 October 2008, the Swiss Government and the Swiss National Bank (SNB) bailed out UBS AG. The bank had already gone through two rounds of capital increases. However, in the aftermath of the failure of Lehman Brothers, most global financial institutions incurred large losses and their capital melted. UBS AG needed to be recapitalized otherwise it would have probably faced a bank run.

    The transaction was structured in two steps: first, the Swiss government subscribed a CHF 6 billion mandatory convertible subordinated note with a coupon of 12.5% per annum, thus recapitalising UBS AG.1 Then, the SNB set up a "bad bank",2 SNB Stab Fund limited partnership for collective investments (SNB Stab Fund), to acquire up to USD 60 billion of illiquid assets from UBS AG. UBS AG financed 10% of the consideration paid by SNB Stab Fund to purchase the illiquid assets, whereas the remaining 90% were financed by the SNB, which extended a secured credit facility to SNB Stab Fund.3 Keeping to central bank regulations, the purpose of this second step was not to recapitalise a financial institution, but only to provide liquidity in extremely difficult circumstances as a lender of last resort.4 A key element in the process was therefore a prudent valuation of the illiquid assets.5 As an additional loss protection, the SNB received a warrant to purchase hundred million UBS...

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