Situation in the banking sector As our Financial Stability Report published today describes in detail, the situation in the Swiss banking sector deteriorated considerably in 2008. The turbulence in the money and credit markets that had erupted in mid-2007 worsened in 2008, also spilling over to other areas. The two big banks, in particular UBS, were hit hard by these negative developments. As you know, together the two institutions recorded a total loss of some CHF 30 billion in 2008. 1 They took extensive measures to strengthen their resilience. In addition to reducing risky positions, they raised sizeable amounts of private capital. The resilience of UBS was further strengthened by the package of government measures announced by the Federal Council, the SNB and the then Swiss Federal Banking Commission (SFBC, now FINMA or Swiss Financial Market Advisory Authority) in October 2008. Owing to all of these measures, the big banks’ capital situation at the end of 2008 improved slightly compared to the end of 2007, despite the massive losses incurred. However, our assessment is that, overall, risks in the big banks’ books are still material. This is all the more serious since, compared to the end of 2007, the profit potential of the big banks is lower. Banks with a domestic business focus, i.e. cantonal, regional and Raiffeisen banks, present a much more favourable picture. Although the overall profitability of these bank categories declined in 2008, it still remains above the long-term average.
In reality, this is precisely where the moral hazard issue associated with the implicit guarantee of the “too big to fail” (TBTF) status becomes relevant. By definition, a TBTF financial institution can expect to be rescued from bankruptcy. As a consequence, the banks’ bondholders know they will not bear the cost of excessive risk-taking and therefore they need not  4  5  Though determining the precise level of socially optimal risk-taking is difficult to gauge for the economy as a whole, excessive risk-taking by an individual institution is easier to detect. In Switzerland, a FINMA circular on remuneration schemes lays down rules for the remuneration of employees of financial institutions. Cf., FINMA Circular 10/1, “Minimum standards for remuneration schemes of financial institutions”, October 2009. 6  Executive compensation schemes which could represent an additional mechanism for improving managerial compensation include schemes that align managerial compensation with the long-term objectives of the firm. Skills are better assessed in relative terms and on a risk-adjusted basis. Therefore, a compensation scheme that rewards better-than-average corporate results and refers to risk-adjusted performance measures may reduce risk-taking and reward more skills. For a more complete discussion, cf. “The Squam Lake Report: Fixing the Financial System”, Princeton University Press, May 2010.