As of 1 January 2018, further elements of the Basel III international regulatory framework for banks on capital and liquidity entered into effect in Switzerland. Notably, the unweighted capital adequacy requirement (leverage ratio) was extended from systemically relevant banks to all banks by requiring a minimum core capital (Tier 1 capital) to total exposure ratio of 3%. As of the same date, the liquidity coverage ratio (LCR) requirement were adjusted to provide for certain simplifications, which will primarily benefit smaller financial institutions. The risk diversification requirements of Basel III measured against Tier 1 capital will enter into effect in Switzerland in 2019. The introduction of the net stable funding ratio (NSFR), which was originally planned for 1 January 2018, has been postponed.

By René Bösch / Benjamin Leisinger / Lee Saladino (Reference: CapLaw-2018-03)

1) The Implementation of Basel III in Switzerland Generally

The comprehensive set of reform measures developed by the Basel Committee on Banking Supervision (BCBS) to strengthen the regulation, supervision and risk management of the banking sector (Basel III: international regulatory framework for banks (Basel III)) was implemented in Switzerland in 2013. Since then, Switzerland has implemented step-by-step elements of the Basel III reform package. Consequently, the BCBS’s Thirteenth progress report on adoption of the Basel regulatory framework of October 2017 demonstrates that Switzerland has made good progress in this area.

2) Leverage Ratio

On 1 January 2018, a leverage ratio requirement of 3% for all banks entered into effect. The leverage ratio is calculated on the basis of the bank’s core capital (Tier 1 capital, i.e., common equity tier 1 (CET1) capital and additional tier 1 (AT1) capital instruments) to total exposure. The total exposure consists of a bank’s unweighted balance sheet exposure, derivative exposure, and securities financing transactions exposures, as well as certain off-balance sheet items. By contrast, the capital adequacy requirement prescribed for all banks is calculated on the basis of the bank’s risk-weighted assets (RWA) only, the amount of which increases with the bank’s size. The leverage ratio requirement is intended to function as a safety net and, as all banks have been reporting their leverage ratio over the past years, we know that almost all Swiss banks have already been meeting or exceeding the 3% leverage ratio requirement for several years.

The systemically important Swiss banks have been subject to a leverage ratio requirement since 2013. Since July 2016, this leverage ratio requirement consists of a minimum requirement of 3%. On top of that, systemically important Swiss banks must hold a buffer of 1.5% of their total exposure, leading to a so-called base requirement of 4.5% of their total exposure, and an additional buffer surcharge, which reflects the relevant bank’s systemic importance. For the two globally systemically important Swiss banks, Credit Suisse and UBS, this currently translates into a 5% leverage ratio requirement. In general, this leverage ratio requirement for systemically important Swiss banks must be met by CET1 capital. Up to 1.5% of the total exposure of the 3% minimum requirement may be held in the form of AT1 capital instruments that automatically convert into common equity or written down pursuant to their terms if the CET1 ratio falls below 7%.

While, since 2016, globally systemically important Swiss banks also have to comply with a gone concern leverage ratio requirement in the same amount that has to be primarily met in the form of bail-in bonds, such requirement does not apply to nationally systemically relevant banks, yet, or other banks.

3) Risk Diversification

As of today, the risk diversification requirement and large exposure limits for all Swiss banks are measured against their total adjusted eligible capital (CET1 capital, AT1 capital and Tier 2 capital). Accordingly, a large exposure exists if the bank’s aggregate exposure to a single counterparty, or a group of related counterparties, is equal to or greater than 10% of the bank’s adjusted eligible capital. The upper limit for any large exposure, which may only be exceeded in limited cases, is currently 25% of the relevant bank’s adjusted eligible capital.

Under the new regime, which will only become effective on 1 January 2019, Tier 2 capital will no longer be taken into account for purposes of measuring a bank’s risk diversification and large exposures. Instead, a large exposure will be determined, and the upper limit for any large exposure will be calculated, on the basis of a bank’s Tier 1 capital only. To take certain Swiss (regulatory) requirements into account, certain exposures, e.g., to central banks or qualified central counterparties, will be exempted from the risk diversification requirement and large exposure upper limit. Under the new regime, the circumstances in which a bank may exceed the upper limit of 25% of its Tier 1 capital will be even more limited, i.e., if the large exposure either (i) is related to client payment services and covered by unencumbered eligible capital, or (ii) results from the affiliation of previously unconnected counterparties or from an affiliation between the bank and other entities active in the financial sector and is not actively being increased. If one of the bank’s large exposures at any time exceeds the upper limit, such event must be reported to FINMA and the bank’s regulatory auditor. Additionally, certain smaller banks (category 4 and 5 under annex 3 of the Banking Ordinance) will benefit from an increased upper limit of 100% of their Tier 1 capital with respect to any large exposures to non-systemically important banks or broker dealers. This increased upper limit is intended to allow these smaller banks to maintain both their network of correspondence banks and their access to the inter-bank market.

The new regime will also introduce a requirement to identify, monitor and report so-called large credit risks, including intra-day.

Additional changes that will come into effect under the new regime relate to rules on the weighting of certain assets and calculation of certain positions when calculating the exposure, as well as the adjustment of some special rules for systemically important Swiss banks.

4) Liquidity Coverage Ratio

Liquidity risk management and the monitoring of Swiss banks has been governed by the Swiss Liquidity Ordinance since 2012. The liquidity coverage ratio (LCR) requirement was introduced into Swiss law in 2014 and is has been effective since January 2015. Accordingly, Swiss banks must meet both qualitative and quantitative liquidity requirements.

The changes to the Swiss liquidity regime that entered into effect in January 2018 are restricted to certain changes required to facilitate matters specifically for smaller banks and minor adjustments that have proven necessary over the past few years. Most importantly, FINMA has the power to grant smaller banks (category 4 and 5 under annex 3 of the Banking Ordinance) certain easing of the requirements related to, e.g., the complexity and liquidity requirements on a stand-alone and consolidated basis.

5) Net Stable Funding Ratio

According to the BCBS’s original implementation date, the Basel III standards regarding the net stable funding ratio (NSFR) should also have entered into force on 1 January 2018. In light of the delay introducing the NSFR in both the European Union and the United States, the Swiss Federal Council decided not to amend the Liquidity Ordinance to introduce NSFR provisions at this stage, but rather to consider next steps on that topic at the end of 2018.

René Bösch (rene.boesch@homburger.ch)
Benjamin Leisinger (Benjamin.leisinger@homburger.ch)
Lee Saladino (lee.saladino@homburger.ch)