Financial Stability Report 2008

Financial Stability Report 2008 ISSN 1661-7835 (printed version) ISSN 1661-7843 (online version) Swiss National Bank Financial Stability Report Published by Swiss National Bank Financial Stability CH-8022 Zurich Telephone +41 44 631 31 11 Languages The report is published in English, French and German Further information [email protected] Subscriptions, individual issues, change of address Swiss National Bank, Library P.O. Box, CH-8022 Zurich Telephone +41 44 631 32 84 Fax +41 44 631 81 14 E-mail: [email protected] Internet The publications of the Swiss National Bank are available on the internet at www.snb.ch, Publications Composition Neidhart + Schön AG, Zurich Copyright Data and data sources Reproduction and publication of figures The banking statistics used in this report are permitted with reference to source based on official data submitted by the individual banks. As of 1995, the data on the Publication date big banks are analysed on a consolidated June 2008 basis. Before 1995 and for the other banks, non-consolidated figures are used. ISSN 1661-7835 (printed version) This document is based on data available ISSN 1661-7843 (online version) as at 30 May 2008. Table of contents 5 Overall assessment Chapters 10 1 General economic and financial conditions 21 2 Profitability 25 3 Risks 32 4 Capital base 36 5 Market assessment Boxes 8 1 Lessons learned 18 2 Chronology of the financial turmoil 22 3 Structure of the Swiss banking sector 30 4 Stress testing the stability of the Swiss banking sector 35 5 Capital regulation 38 6 Stress index for the Swiss banking sector 2008 Financial Stability Report SNB 4 2008 Financial Stability Report Foreword over, the default rate among borrowers – excluding In accordance with the National Bank Act sub-prime mortgages in the US – continues to be (art. 5 para. 2 (e) NBA), the Swiss National Bank low in historical terms. In Switzerland in particular, is required to contribute to financial stability. This the economy remains in relatively good shape. report highlights the main trends in the Swiss However, the speed of expansion has slowed since banking sector with respect to their impact on the beginning of the year and uncertainty sur- financial stability. A stable financial system can be rounding the outlook has increased. defined as a system where the various components fulfil their functions and are able to withstand the Results vary for different bank categories shocks to which they are exposed. Against this backdrop, the Swiss banking sec- The report presents the SNB’s evaluation of tor should be assessed from two different perspec- the stability of the banking sector and provides the tives. On the one hand, the two big banks – UBS in general public with relevant information and indi- particular – were severely affected by the financial cators. The report gives the SNB the opportunity to turmoil in the second half of the year. Losses from highlight tensions or imbalances that could jeopar- trading operations were only partially offset by dise this stability. It is not the purpose of this good results in other business areas. As report to analyse the solvency of individual finan- a consequence, profitability decreased markedly. On cial institutions. Individual banks are only consid- the other hand, most of the remaining banks and, in ered if this is deemed relevant for obtaining an particular, those with a domestic business focus, overall picture. such as cantonal, regional and Raiffeisen banks, benefited from the favourable state of the Swiss economy and were able to surpass their good results Overall assessment of the previous year. Banks’ varied earnings performances are also Deterioration in the global economic climate reflected in the development of their capital base. After several years of rapid economic growth While the capital base at banks with a domestic and low risk premia in the financial markets, 2007 business focus further improved, risk-weighted saw the onset of global financial turmoil. Given capital ratios of the big banks dropped significant- that a number of macroeconomic and financial mar- ly in 2007. Recent steps taken to raise new capital ket imbalances had built up over the last few years, and reduce risk taking should ensure that the big the deterioration of financial conditions did not banks’ risk-weighted capital ratios remain well come as a total surprise. Yet the global dimension above the regulatory minimum and at high levels and suddenness of these developments surprised by international standards. At the same time, the many observers and market participants. In partic- leverage of Swiss big banks remains very high, ular, the fact that liquidity dried up in a number of despite recent efforts to reduce it. While leverage markets was unexpected. may be an attractive way for banks to increase The first signs of weakness in the US housing return on equity, it is also a source of vulnerability. market emerged as early as 2006, when growth in As the current turmoil has shown, one consequence US property prices began to slow. At the same time, of high leverage is that losses which are small in delinquency rates increased among sub-prime mort- comparison to a bank’s assets can deplete a signif- gage borrowers. In August 2007, market conditions icant portion of its capital. deteriorated dramatically. The risk premia increased The contrasting results of the different bank in the financial markets and the prices for securi- categories are also reflected in market indicators. ties closely linked to the US sub-prime market For instance, in the case of banks with began to drop sharply. a domestic business focus, credit spreads have only Despite these negative developments, key edged up modestly. In contrast, credit default swap indicators show that the overall macroeconomic (CDS) prices for the two big banks have increased conditions in which the Swiss banking sector oper- significantly. Despite easing down markedly after ates remain relatively robust. With the exception of peaking in March 2008, they remain high by histor- the US, where economic growth almost petered out ical standards. in the final quarter of 2007, most economies continue to report relatively high growth rates. More- SNB 5 2008 Financial Stability Report Higher level of stress in the Swiss the big banks, the outlook is cautiously positive. banking sector This does not mean that a slowdown in global The developments outlined above are reflect- macroeconomic growth would leave banks unaffected in the SNB Stress Index (cf. chart 1 and box 6, ed. So far, the financial turmoil has primarily p. 38), which combines comprehensive information affected the big banks’ trading portfolios. Loan on potential symptoms of stress in the Swiss bank- portfolios, and hence the banks’ banking books, ing sector in order to indicate the industry’s current have remained more or less unaffected. As a result, stress levels. According to this index, the situation non-performing loans in the portfolios of Switzer- in the Swiss banking sector worsened sharply in land’s banks, including the big banks, are still at 2007. The rise in the Stress Index in the second half a very low level in historical terms. This situation of 2007 constituted the most substantial six-month might deteriorate if delinquency rates increase fur- climb ever observed in the data series at our dis- ther due to slowing economic growth in the US and posal (since 1987). Judging by the index level, the other key markets. situation in the Swiss banking sector during the Furthermore, although a moderate slowdown current turmoil has been as difficult as it was dur- is the most likely scenario, market participants in ing the domestic housing market crisis at the general – and banks in particular – should take beginning of the 1990s or the Russian crisis in account of the fact that risks to the outlook are rel- 1998. atively large and tilted to the downside. For instance, a contraction of economic activity in the Outlook US with a knock-on effect for many of the world’s The outlook regarding price developments in other economies remains a possibility. Under such a the US housing market and potential consequences scenario, house price corrections would become for the rest of the economy remains highly uncer- more likely in other countries. Unlike in Switzer- tain. The most likely outcome is that global eco- land, property prices in certain European markets nomic growth will slow moderately in 2008 before have been rising at a similar or higher rate than recovering in 2009. For Switzerland, the Swiss they did in the US before the onset of the real National Bank (SNB) expects that real GDP growth estate crisis. in 2008 should range between 1.5% and 2%, as Even though they substantially reduced their compared to 3.1% in 2007. level of exposure to the US housing market, the Under this scenario, the outlook for the Swiss Swiss big banks continue to be exposed to inter- banks with a domestic focus is mostly positive; for national credit and market risks through both their Stress index* Chart 1 In standard deviations 3 2 1 0 –1 –2 –3 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Sources: Swiss Federal Banking Commission (SFBC), Swiss National Bank (SNB), Thomson Datastream *The higher the level of the index, the higher the level of stress in the Swiss banking sector. The index is expressed in terms of standard deviations from its 1987–2007 average. A value above (below) zero indicates that the stress is above (below) its historical average. The stress index for the first quarter of 2008 has been computed with provisional data.

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