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      Bank Capital Quarterly: dealing with the TBTF dilemma
      TUESDAY, 14/05/2024 - Scope Ratings GmbH
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      Bank Capital Quarterly: dealing with the TBTF dilemma

      Significant efforts have been made since the GFC to improve the supervision of systemically important banks and address the issue of too-big-to-fail. But on this and the effectiveness of AT1s in supporting G-SIB recovery, there is room for improvement.

      “The G-SIB framework has been in place for more than 10 years as a way to address the too-big-to-fail (TBTF) dilemma. In that time, data suggests that banks have broadly adjusted their balance sheets in line with the objectives of supervisory authorities,” said Pauline Lambert, executive director in Scope’s financial institutions team. “The fact that the average G-SIB score has declined due to reduced complexity and interconnectedness but also in relation to the development of the broader economy and financial system suggests the role of G-SIBs has diminished over time.”

      The Basel Committee on Banking Supervision is considering fine-tuning aspects of the G-SIB assessment framework to address the material seasonality of G-SIB indicators at year-end because of window dressing practices. This will require banks to report indicators based on average values over a year rather than year-end values. To give banks sufficient time to develop their reporting capabilities, the proposed implementation date is 1 January 2027 with a transitional period starting from 1 January 2026.

      Overall European G-SIB scores (end-2022)

      Source: BIS, Scope Ratings

      Lessons from Credit Suisse

      The Swiss Federal Council also announced a broad package of measures in April to strengthen the country’s TBTF regime, reflecting lessons learned from the Credit Suisse crisis. The three areas of focus are prevention, i.e. reducing the likelihood of a systemically important bank getting into a critical situation; ensuring liquidity in a crisis at bank level and via the central bank and a public liquidity backstop; and expanding the crisis toolkit with expanded resolution plans and better crisis co-ordination among authorities.

      The findings of the Swiss Parliamentary Investigation Committee’s review of the emergency Credit Suisse merger – expected at the end of this year – will also be considered in any amendments to the TBTF regime. The Federal Council intends to present two packages for implementation in the first half of 2025: one for measures it can bring in at ordinance level (those relating to capital requirements) and another for those requiring legislative amendments (relating to liquidity, corporate governance and resolution planning).

      “On capital-related measures, the proposed measures address two weaknesses of the Swiss TBTF regime: capital requirements are not forward-looking in nature and the capitalisation of parent banks in international financial groups. One measure would introduce forward-looking elements into institution-specific Pillar 2 capital add-ons based on stress tests and ongoing supervision. This measure would align Swiss supervisory practices with those in the EU and UK,” Lambert said.

      “Another measure proposes to increase the required capital for foreign participations held by parent banks within a financial group,” Lambert continued. This could be achieved by raising the risk weights for these participations or by deducting them from regulatory capital. Under current regulations, parent banks must hold capital backing 60% of participations in foreign subsidiaries.

      To increase the going-concern risk-absorbing function of AT1 instruments (a recurring theme), the Federal Council is also considering changing the rules such that calling AT1 instruments would be allowed only in exceptional circumstances, making it easier to avoid signalling a weakness when not called. The conditions under which the securities are eligible as AT1 capital could also be further defined and tightened in regulatory requirements. In making changes, the Swiss authorities will need to weigh the costs and benefits to financial stability and international competitiveness.

      Download the Bank Capital Quarterly here.

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