The last-minute rescue of Credit Suisse may have prevented the current banking crisis from exploding, but it’s a raw deal for Switzerland.
Worries that Credit Suisse’s downfall would spark a broader banking meltdown left Swiss regulators with few good options. A tie-up with its larger rival, UBS (UBS), offered the best chance of restoring stability in the banking sector globally and in Switzerland, and protecting the Swiss economy in the near term.
But it leaves Switzerland exposed to a single massive financial institution, even as there is still huge uncertainty over how successful the mega merger will prove to be.
“One of the most established facts in academic research is that bank mergers hardly ever work,” said Arturo Bris, a professor of finance at Swiss business school IMD.
There are also concerns that the deal will lead to huge job losses in Switzerland and weaken competition in the country’s vital financial sector, which overall employs more than 5% of the national workforce, or nearly 212,000 people.
Taxpayers, meanwhile, are now on the hook for up to 9 billions Swiss francs ($9.8 billion) of future potential losses at UBS arising from certain Credit Suisse assets, provided those losses exceed 5 billion francs ($5.4 billion). The state has also explicitly guaranteed a 100 billion Swiss franc ($109 billion) lifeline to UBS, should it need it, although that would be repayable.
Switzerland’s Social Democratic party has already called for an investigation into what went wrong at Credit Suisse, arguing that the newly created “super-megabank” increases risks for the Swiss economy.
The demise of one of Switzerland’s oldest institutions has come as a shock to many of its citizens. Credit Suisse is “part of Switzerland’s identity,” said Hans Gersbach, a professor of macroeconomics at ETH university in Zurich. The bank “has been instrumental in the development of modern Switzerland.”
Its collapse has also tainted Switzerland’s reputation as a safe and stable global financial center, particularly after the government effectively stripped shareholders of voting rights to get the deal done.
Swiss authorities also wiped out some bondholders ahead of shareholders, upending the traditional hierarchy of losses in a bank failure and dealing another blow to the country’s reputation among investors.
“The repercussions for Switzerland are terrible,” said Bris of IMD. “For a start, the reputation of Switzerland has been damaged forever.”
That will benefit other wealth management centers, including Singapore, he told CNN. Singaporeans are “celebrating… because there is going to be a huge inflow of funds into other wealth management jurisdictions.”
Too big to fail?
At roughly $1.7 trillion, the combined assets of the new entity amount to double the size of Switzerland’s annual economic output. By deposits and loans to Swiss customers, UBS will now be bigger than the next two local banks combined.
With a roughly 30% market share in Swiss banking, “we see too much concentration risk and market share control,” JPMorgan analysts wrote in a note last week before the deal was done. They suggested that the combined entity would need to exit or IPO some businesses.
The problem with having one single large bank in a small economy is that if it faces a bank run or needs a bailout — which UBS did during the 2008 crisis — the government’s financial firepower may be insufficient.
At 333 billion francs ($363 billion), local deposits in the new entity equal 45% of GDP — an enormous amount even for a country with healthy public finances and low levels of debt.
On the other hand, UBS is in a much stronger financial position than it was during the 2008 crisis and it will be required to build up an even bigger financial buffer as a result of the deal. The Swiss financial regulator, FINMA, has said it will “very closely monitor the transaction and compliance with all requirements under supervisory law.”
UBS chairman Colm Kelleher underscored the health of UBS’s balance sheet Sunday at a press conference on the deal. “Having been chief financial officer [at Morgan Stanley] during the last global financial crisis, I’m well aware of the importance of a solid balance sheet. UBS will remain rock-solid,” he said.
Kelleher added that UBS would trim Credit Suisse’s investment bank “and align it with our conservative risk culture.”
Andrew Kenningham, chief Europe economist at Capital Economics, said “the question of market concentration in Switzerland is something to address in future.” “30% [market share] is higher than you might ideally want but not so high that it’s a major problem.”
The deal has “surgically removed the most worrying part of [Switzerland’s] banking system,” leaving it stronger, Kenningham added.
Jobs and competition
The deal will have an adverse affect on jobs, though, likely adding to the 9,000 cuts that Credit Suisse already announced as part of an earlier turnaround plan.
For Switzerland, the threat is acute. The two banks collectively employ more than 37,000 people in the country, about 18% of the financial sector’s workforce, and there is bound to be overlap.
“The Credit Suisse branch in the city where I live is right in front of UBS’s, meaning one of the two will certainly close,” Bris of IMD wrote in a note Monday.
In a call with analysts Sunday night, UBS CEO Ralph Hamers said the bank would try to remove 8 billion francs ($8.9 billion) of costs a year by 2027, 6 billion francs ($6.5 billion) of which would come from reducing staff numbers.
“We are clearly cognizant of Swiss societal and economic factors. We will be considerate employers, but we need to do this in a rational way,” Kelleher told reporters.
Not only does the deal, done in a hurry, fail to protect jobs in Switzerland, but it contains no special provisions on competition issues.
UBS now has “quasi-monopoly power,” which could increase the cost of banking services in the country, according to Bris.
Although Switzerland has dozens of smaller regional and savings banks, including 24 cantonal banks, UBS is now an even more dominant player. “Everything they do… will influence the market,” said Gersbach of ETH.
Credit Suisse’s Swiss banking arm, arguably its crown jewel, could have been subject to a future sale as part of the terms of the deal, he added.
A spinoff of the domestic bank now looks unlikely, however, after UBS made clear that it intended to hold onto it. “The Credit Suisse Swiss bank is a fine asset that we are very determined to keep,” Kelleher said Sunday.
Integration is difficult
At $3.25 billion, UBS got Credit Suisse for 60% less than the bank was worth when markets closed two days prior. Whether that ultimately turns out to be a steal remains to be seen. Large mergers are notoriously fraught with risk and often don’t deliver the promised returns to shareholders.
UBS argues that by expanding its global wealth and asset management franchise, the deal will drive long-term shareholder value. “UBS’s strength and our familiarity with Credit Suisse’s business puts us in a unique position to execute this integration efficiently and effectively,” Kelleher said. UBS expects the deal to increase its profit by 2027.
The transaction is expected to close in the coming months, but fully integrating the two institutions will take three to five years, according to Phillip Straley, the president of data analytics company FNA. “There’s a huge amount of integration risk,” he said.
Moody’s on Tuesday affirmed its credit ratings on UBS but changed the outlook on some of its debt from stable to negative, judging that the “complexity, extent and duration of the integration” posed risks to the bank.
It pointed to challenges retaining key Credit Suisse staff, minimizing the loss of overlapping clients in Switzerland and unifying the cultures of “two somewhat different organizations.”
According to Kenningham of Capital Economics, the “track record of shotgun marriages in the banking sector is mixed.”
“Some, such as the 1995 purchase of Barings by ING, have proved long-lasting. But others, including several during the global financial crisis, soon brought into question the viability of the acquiring bank, while others have proven very difficult to implement.”