The Swiss new capital requirements – why cheer?

Today Finma, the Swiss bank supervisor posted its new Leverage Ratio requirement,  see picture:

finma

Switzerland has decided to set a TLAC of 10% of total exposure for its global systemically important banks: 5% for going concern and 5% for gone concern, in line with the TLAC proposal of the FSB.

Finma uses colourful language to announce that they are now taking the lead internationally by introducing more stringent capital requirements. All very impressive.

So far so good.

But what worries me is the structure of capital. 30% of the Tier 1 requirement can be met with CoCo’s and 70% with equity. The new requirement splits the 5% into 3% 3.5% for CET1 and 2% 1.5% Additional Tier 1 hybrids. Note the source of confusion in the Finma document:

finmaerr

We learned from the GFC that CoCo’s did not absorb losses. This is why Basel III gave them a limited role. Basel III Tier 1 hybrids can only count toward 21% of Tier 1 (1.5% over 7%; where I include the conservation buffer into the Tier 1 requirement), whereas under Basel II this could be 50% or more.

The problem with 30% CoCos in Tier 1 is the sheer size of this slice: 30%! It may fail to absorb losses. For example, retail investors may win a court case after a write-down or conversion, forcing the bank to indemnify them. This happened to Lloyds not so long ago.

In addition, the CoCos may end up in the hands of retail investors. Post-conversion, they may become owners. The Wall Street Journal wrote about this post-conversion problem affecting the Bank of Cyprus: “The bailed-in depositors now hold roughly 80% of the newly issued shares in Bank of Cyprus and essentially control the board of directors. As a result, the new board is now a mélange of Russian oligarchs … , Cypriot pension and provident funds, and a hodge-podge of other representatives who never expected to be running a bank, much less owning one.

So I wonder why pundits celebrate Finma’s move. As CoCos create lots of uncertainties post conversion, I fail to see how that serves financial stability.

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