By Julian Zimmermann, Senior Analyst, Sovereign Ratings

The unprecedented, last-minute deal, to be completed in coming weeks, should help contain the financial cost of stabilising the pressured Credit Suisse for the Swiss Confederation (AAA/Stable) and contain potential spill-over to the wider Swiss economy.

The events highlight long-standing contingency risks to the sovereign stemming from the banking system, given its large size relative to the economy and Switzerland’s annual budget.

Total assets in the Swiss banking system stood at CHF 3.5trn at the end of 2022, or around 448% of GDP (Figure 1). UBS accounted for 132% of GDP at YE 2022, while the much-reduced balance sheet of Credit Suisse accounted for 69%. Hence, the combined balance sheet of UBS and Credit Suisse amounted to around CHF 1.55trn, or around 200% of GDP. The merger thus results in a greater concentration of contingency risks for Switzerland.

Figure 1: Size of Swiss banking system
Swiss banking system total assets, % of GDP

Source: Swiss National Bank, SECO, Scope Ratings

Beyond balance-sheet metrics, the Swiss banking system also contributes significantly to the domestic economy via its contribution to gross value added (GVA, 5.9% of the total on average 2017-2022) and to employment (3.6% in 2022 according to BAK Basel).

Swiss government uses financial strengths to full advantage

The Swiss government has used its financial power to help find a solution to the Credit Suisse crisis by providing a guarantee of CHF 9bn (around 1.2% of GDP) to UBS to cover potential losses above CHF 5bn from winding down some Credit Suisse positions. In addition, the government has provided a CHF 100bn (13% of GDP) guarantee to the Swiss National Bank (SNB) to provide further liquidity via a newly established Public Liquidity Backstop (PLB) facility which does not need to be collateralised.

The liquidity provided by the SNB via the PLB benefits from preferred creditor status which helps mitigate sovereign risk. So does the ample capitalisation of Credit Suisse and the write-down of the bank’s AT1 securities of CHF 16bn that increases core equity. Should the SNB incur uncovered losses on any of its exposures, this would affect the Confederation and Swiss cantons through SNB annual profit allocations, as was the case when the SNB’s 2022 losses of CHF 133bn prohibited any profit allocation.

The merger is designed to help draw a line under Credit Suisse’s problems, driven by substantial deposit outflows in the final quarter of 2022, visible in the decline in non-domestic, dollar-denominated deposits in the Swiss banking system (Figure 2).

Figure 2: Foreign-held USD deposits have been withdrawn rapidly in Q4 2022
Foreign-owned deposits in Swiss banks by currency denomination, CHF m

Source: Swiss National Bank, Scope Ratings

Robust regulatory regime tested; economic consequences to come

However, there will be domestic economic consequences. The announced merger is certain to lead to job cuts at Credit Suisse, which employed around 50,000 persons globally and 17,000 in Switzerland, or around 11% of total employment in the banking sector.

The sector’s contribution to GVA will also suffer. As a point of reference, real GVA from financial services dropped by 11% in 2008 during the great financial crisis, when UBS required state support, and took until 2020 to recover its 2007-level. Finally, given the merged entity’s dominant position in the Swiss banking system, there are risks that competition and efficiency will be adversely affected. According to UBS, the merged entity would be the domestic leader in terms of deposits and loans outstanding.

That said, we acknowledge that Switzerland’s strengthened regulatory regime has contributed to mitigate even larger contingency risks. FINMA’s too-big-too-fail resolution regime (TBTF) includes additional regulatory requirements for systemic banks. At the same time, the TBTF regime was not fully utilised in this case, which would have included the conversion of bail-in bonds, as the authorities favoured a solution via private players.

In addition, liquidity needs in foreign currency, in particular in dollars, can be covered through dollar auctions of the SNB, now held daily, which can itself mobilise dollars via a standing dollar swap line with the US Federal Reserve and via its foreign exchange reserves of CHF 801bn at YE 2022, 38% of which were denominated in dollars, acting as a potential second line of defence.

Switzerland has significant shock-absorbing capacity given credit strengths of a very wealthy and well-diversified economy, solid public finances and strong external metrics: public debt stood at a modest 42.1% of GDP at the end of 2021, while real GDP growth was 4.2% in 2021 and 2.1% in 2022.