Even though Swiss and international financial regulations have constantly evolved over the years, and are likely to continue to do so, it is possible to identify 5 key regulatory ratios that are most closely monitored in a Swiss bank. This article details each of these indicators, their objectives and their effectiveness. You will also find the acts and FINMA Circulars that currently govern them, as well as the potential impact of Basel III final.
0 – Change in regulatory ratios over time
This article will detail the five most important key indicators that Swiss banks must meet under current financial regulations. These ratios have changed several times. Smaller banking institutions have a number of simplification rules (“proportionality”) at their disposal.
0.1 – The work of the Basel Committee
Switzerland is a member of the Basel Committee on Banking Supervision (BCBS). Its aim is to strengthen the reliability and security of the international banking system. Since its creation in 1974, this institution has proposed numerous indicators or ratios, through its guidelines and standards, to measure and limit banks’ risk-taking.
However, despite this desire to standardize the financial approach to risk, it is sometimes complicated to cover all the realities of financial institutions with different business models and environments. Controlling risk through regulatory ratios while promoting growth and economic activity seems to be more an art than an exact science.
0.2 – The impact of financial crises on regulatory ratios
After the major global crisis of 2008, the Basel Committee carried out a series of reforms known as Basel III to strengthen capital and liquidity controls. The publication of the final standards in 2017 completes the 2013 package of new measures. That’s why the name of these latest regulations is Basel III final. Implementation in Switzerland is scheduled for 2025.
Indicators evolve with each crisis, and hopefully gain in maturity with each change. However, these new approaches have not been enough to prevent the banking sector worldwide, in the USA or Switzerland, from experiencing difficulties in 2023. Further changes are likely to follow.
0.3 – A constant objective : risk sensitivity
The various regulatory ratios used by Swiss banks are designed to measure risk across various business activities. They are useful to estimate the risk taken, thanks to transparent and simple indicators. This is why the Basel Committee’s discussion paper published in July 2013 is entitled “The regulatory framework: balancing risk sensitivity, simplicity and comparability”.
1 – Capital ratio requirements at Swiss banks
Capital requirements are part of Pillar 1 of the Basel Capital Accord. It specifies the capital to be taken into account. It also sets out the methods for calculating minimum capital requirements for credit, operational and market risks.
1.1 – A risk-weighted regulatory ratio
This is the driving capital requirement in Switzerland. Banks’ assets are risk-weighted by different percentages. RWA means risk-weighted assets. These weighted assets are then related to the (adjusted) capital of the bank.
1.2 – Capital requirements under current regulatory texts
This regulatory requirement has evolved over time. Currently, regulatory requirements demand this calculation for credit risk, market risk and operational risk.
Note that the Basel Committee does not require the calculation of capital for interest-rate risk in Pillar 1. However, it is integrated into Pillar 2, which deals with capital adequacy and risk management. Switzerland has translated this into the capital planning regulation, in accordance with FINMA Circular 11/02. With the current global banking crisis, we are wondering about the absence of mandatory capital requirements for interest-rate risk.
1.3 – Introduction of the leverage ratio (LR), a ratio without risk weighting
The capital adequacy ratio as defined above has sometimes been misused in the past. Some banks had invested in AAA-rated assets, that means with a 0% risk weighting. Actually, the risk existed. As a result, regulators modified the requirements in two ways. On the one hand, they tightened the rules on the use of external ratings.
On the other hand, they have implemented tougher regulations with the introduction of the “leverage ratio” (LR). This is an unweighted capital ratio. It’s a percentage of total commitments. This notion of maximum leverage corresponds to the ratio between assets and adjusted capital. It places an absolute limit on possible leverage.
1.4 – Capital requirement : Swiss regulatory sources
For these regulatory ratios relating to bank solvency, please refer to the Swiss Capital Adequacy Ordinance (CAO). Appendix 8 of the CAO defines the minimum total equity. FINMA Circulars complete the rules to be applied. Please note that these texts will be amended whit Basel III implementation.
2 – LCR or Liquidity Coverage Ratio
This regulatory ratio for bank liquidity was added after the 2008 financial crisis.
2.1 – Definition of LCR
The aim is to ensure that each bank always has sufficient liquidity to meet its payment obligations, even in the event of a crisis. Keeping sufficient liquidity in reserve should enable banking institutions to get through a difficult situation, in the event of sudden deterioration.
The Basel Committee has designed this indicator so that high quality liquid assets (HQLA) secures the bank’s liquidity in the event of a crisis for 30 calendar days. It is a standardized liquidity stress test, based on outflows and inflows assumptions.
2.2 – Calculation of LCR ratio
In accordance with article 13 of the Swiss Liquidity Ordinance (LiqO), the LCR corresponds to the ratio between HQLA (high-quality liquid assets) outstanding and the net cash outflow expected at 30 days in a crisis situation. To comply with the LCR requirements, the bank must have a ratio greater than or equal to 1.
2.3 – Current limits of the Liquidity Coverage Ratio
Recent emergency takeovers to avoid bankruptcies have highlighted the need to change the LCR ratio. It is no longer fully adapted to our times, when money can leave a bank even faster than this indicator allows.
2.4 – Liquidity ratio : regulatory documents
In Switzerland, the Liquidity Ordinance (LiqO) defines the LCR in terms of both quantitative and qualitative requirements. FINMA Circular 15/02 sets out the rules of application. The implementation of Basel III in Switzerland will not modify these texts. In a way, this is good news for the simplification of financial regulation.
3 – The leverage ratio
This indicator introduces the notion of a maximum gearing ratio, in line with the requirements of the pillar 1 of the Basel regulations.
3.1 – Purpose of this banking ratio
This is an unweighted risk-adjusted capital ratio. This regulatory indicator restricts a bank’s maximum leverage effect. It places an absolute limit on the size of the bank’s balance sheet, as opposed to the risk-based capital ratio.
3.2 – Leverage ratio : information sources for Switzerland
In our country, the leverage ratio requirements are set out in the Capital Adequacy Ordinance (CAO), supplemented by FINMA Circular 15/03. These texts will be amended to incorporate the final Basel III standard.
3.3 – Level of leverage ratio required in Switzerland
According to CAO Art. 46, non-systemic Swiss banks must have core capital of at least 3% of unweighted positions. This level is in line with the Basel minimum standards.
4 – NSFR regulatory ratio
NSFR means Net Stable Funding Ratio. It is also known as the funding ratio. It is one of the major reforms introduced by the Basel Committee after the 2008-2009 financial crisis.
4.1 – Definition and role of the regulatory ratio
The purpose of this indicator is to ensure the long-term funding of banking institutions. Thus, the Basel Committee wrote in 2014 that “The NSFR will require banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities”. With such a financial structure, the risk of default decreases. For now, however, the impact of this ratio doesn’t seem to be very significant in Switzerland.
4.2 – Financial regulations relating to the NSFR : texts to use
The Liquidity Ordinance (LiqO) governs the NSFR ratio. FINMA Circular 15/02 sets out the application rules. The final implementation of Basel III will have no impact on these regulatory requirements in Switzerland.
4.3 – Calculation and level of the funding ratio in Switzerland
Article 17g of LiqO details the calculation of the NSFR. It is the ratio of Available Stable Funding (ASF) to Required Stable Funding (RSF). Minimum requirements correspond to an NSFR of at least 1.
5 – Concentration risks
Even if this is not strictly a regulatory ratio, the limits applicable to large exposures can sometimes be structuring. They require active monitoring.
5.1 – Specific rules in order to limit the risk of bank concentration
The aim is to measure and limit the risk of excessive concentration among banking institutions. In our view, these indicators are quite effective. Based on our experience, it is, after the capital requirement ratio, one of those that raises the most questions.
5.2 – Regulatory texts governing major risks
The Capital Adequacy Ordinance (CAO) regulates “large exposures”, notably in Title 4. Article 95 defines “large exposure” as the total position with a counterparty or group of related counterparties reaching or exceeding 10% of adjusted core capital.
Art. 109 defines the concept of a group of related counterparties. Finally, FINMA Circular 19/01 sets out the practical implementation. Basel III final will have no impact on this point. The current Swiss version of Basel III already takes into account all Basel standards.
Swiss regulatory ratios are still evolving
Over the past few years, regulators have been working hard to change banking ratios at international level, in order to limit banks’ risk without slowing their growth and innovation. These ongoing changes are set to continue.
In a fast-moving and dynamic society where innovation is constantly shaking up practices, today’s banking indicators will probably no longer be appropriate tomorrow. Regulators will have to incorporate new concepts to respond to the financial crisis of 2023, particularly in terms of liquidity and interest-rate risk. But these will not be the only changes. Sustainability ratios, among others, will be added to current requirements. The regulatory process continues to adapt !
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