The Swiss authorities' proposal to revise the banking act by granting additional emergency and extraordinary liquidity assistance to systemically important banks (SIBs) is under review. If enacted, the proposal would codify the emergency ordinance that the authorities adopted in March 2023 when Credit Suisse was close to failure. S&P Global Ratings sees the creation of a broader and more comprehensive emergency liquidity support framework as generally supportive of our view of industry risk in our banking industry country risk assessment (BICRA), although it is unlikely to change our view in this instance.

We see the proposal as more relevant to our approach to rating Swiss additional Tier 1 (AT1) instruments, as it could change our view of SIBs' loss-absorption risk. Exactly how our view will change depends on our assessment of various aspects of the new legislation, including whether we see the write-down of AT1 instruments as mandatory, and whether the risk of write-down merits additional notching for our issue ratings on some or all Swiss AT1 instruments.

The proposal to revise the banking act follows the Swiss Federal Council's (SFC's) adoption, on March 16, 2023, of an emergency ordinance to set up a liquidity facility to safeguard the orderly takeover of Credit Suisse by UBS. Under the emergency ordinance, Credit Suisse and UBS were able to jointly obtain an emergency liquidity loan of up to Swiss franc (CHF) 100 billion that gives the Swiss National Bank (SNB) privileged creditor status in bankruptcy. The emergency ordinance also allowed the SNB to grant Credit Suisse a liquidity assistance loan (LAL) of up to CHF100 billion, backed by a federal default guarantee.

At the time, the facilities acted as a backstop for Credit Suisse's and UBS' liquidity positions and were, in the eyes of the federal government, necessary to rebuild trust in Credit Suisse. The provision of the federal guarantee for the LAL appears to have been the catalyst for the Swiss Financial Market Supervisory Authority's (FINMA's) decision that a "viability event" had occurred, on the grounds that extraordinary government support had been extended to Credit Suisse, which in turn led to the write-off of Credit Suisse's AT1 instruments.

Although the SFC acted in accordance with the Swiss federal constitution, it has to review its emergency ordinance within six months after enactment to turn it into ordinary law. The government has therefore published its first revision of the Swiss banking act following a consultation period that ended on June 21, 2023. Now the authorities will assess the responses from cantons, political parties, and associations.

Additional Liquidity Assistance Will Complement The Existing Support Framework

The SFC intends to enshrine in law the possibility of granting additional emergency liquidity assistance (ELA+) as well as LALs to Swiss SIBs to allow them to restructure or wind down their businesses while safeguarding trust and avoiding a disorderly failure. The proposal follows the Financial Stability Board's (FSB's) publication of guiding principles on funding for an orderly resolution of global SIBs in August 2016. The FSB's guidelines advise authorities to introduce a credible public sector backstop mechanism to fulfil a bank's temporary funding needs to the extent necessary to maintain the continuity of its critical functions in resolution.

Until now, Swiss banks either had to rely on the SNB's liquidity-shortage financing standing facility to bridge unexpected, short-term liquidity bottlenecks, or request emergency liquidity assistance (ELA; see chart below). The liquidity-shortage financing standing facility is open to all banks in Switzerland, and is drawable via a special-rate repo transaction. In its role as a lender of last resort, the SNB stipulates that banks must cover ELA loans with collateral that it deems sufficient. This could involve transferring Swiss mortgages or pledging securities to the SNB. Banks seeking ELA must also be important for the stability of the financial system, and solvent.

Under the proposed legislation, if the existing measures prove insufficient in the event of a crisis, the SFC, in consultation with the SNB, would have the power to grant ELA+. It would grant this on an unsecured basis, but secure it by assigning it preferential rights in bankruptcy proceedings.

If the SNB determines that a stressed bank has no more liquid assets, nor sufficient access to market liquidity, nor any possibility of drawing on ELA or ELA+ to cover its own liquidity needs, the proposed legislation would offer a new public liquidity backstop mechanism, or LAL. LALs have three prerequisites, namely:

• The bank must be systemically important or part of a systemically important financial conglomerate;
• FINMA needs to have either instructed recovery measures or have plans to do so; and
• The bank will need to prove that it has adequate capitalization or prospects of the same following the execution of its restructuring plan.

The SFC has stressed that SIBs have no automatic right to an LAL, and the Swiss government can choose not to provide such support even if an institution meets all the prerequisites. If it does grant an LAL, the SFC must prove that not doing so would lead to substantial damage to the Swiss financial system or economy, and that the backstop is suitable and necessary for the recovery of the institution. These LALs would only be valid until December 2027, when the legislation would be subject to another review.

The Potential Rating Implications Center On Swiss AT1 Instruments

We see the proposal as relevant to our approach to rating Swiss AT1 instruments as it could change our view of SIBs' loss-absorption risk. Exactly how our view will change depends on our assessment of various aspects of the new legislation, specifically:

FINMA's authorization to write down AT1 instruments as a consequence of the liquidity backstop.  FINMA showed willingness to make use of its specific powers to deal with Credit Suisse's stress event. As institutions will need to be solvent to access the backstop, a write-down might happen before the instrument's regulatory capital ratio-based trigger event.

The risk of AT1 instruments being written down.  While a write-down would not be mandatory, we will assess whether we see it as likely, considering FINMA's write-off of Credit Suisse's AT1 instruments.

Whether this risk merits additional notching for our issue ratings on some or all Swiss AT1 instruments.  These include instruments issued by SIBs even when such a stress event is remote.

How likely some SIBs would be to use LALs.  We will assess whether the partial or full government ownership of some SIBs like PostFinance and Zuercher Kantonalbank implies that, in practice, they would be unlikely to need LALs, as they have the option of obtaining direct support from either the Swiss government or the cantons. However, we believe that liquidity support in meaningful amounts can only be provided by the SNB, the lender of last resort.

We reflect the risk of a hybrid instrument default by notching down our issue ratings

Our hybrid capital rating methodology acknowledges the risk that issuers could default on hybrid debt such as AT1 instruments earlier than senior debt through write-downs, coupon deferrals, or other loss-absorption mechanisms. This risk mainly arises from the hybrid instruments' contractual and statutory features. However, FINMA's decision to write off Credit Suisse's AT1 instruments also highlights the considerable latitude that regulatory and legislative processes can provide when authorities need to ensure financial stability in an emerging crisis (see: "Swiss Regulator's Statement On Credit Suisse AT1 Confirms Impact Of Documentation And Legislative Powers," published March 23, 2023).

We reflect these risks by notching down our issue ratings on hybrid instruments from a starting point, which is the stand-alone credit profile or in some circumstances the issuer credit rating on a bank. This is in addition to our notching for the instrument's contractual subordination features. We may widen the notching when a bank comes under stress, if we see this as heightening the default risk on certain hybrid instruments relative to senior debt. For a European bank, default risk--whether through discretionary coupon nonpayment or going-concern write-down triggers--typically rises when its creditworthiness weakens. Weaker regulatory capital ratios are only one indicator of weaker creditworthiness.

We see comprehensive liquidity support frameworks as a supportive factor for industry risk under our BICRAs

They may also be relevant to our view of an individual bank's access to contingent liquidity where they extend its ability to monetize its assets and thereby support its resilience. In addition, they may inform our view of the potential effectiveness of a jurisdiction's resolution framework when we consider the applicability of rating uplift for additional loss-absorbing capacity. Indeed, we have long highlighted the lack of a codified backstop in Europe outside the U.K., and EU policymakers continue to explore ways to extend the European Central Bank's backstop lending capacity beyond the resources of the Single Resolution Fund and European Stability Mechanism (see "The Resolution Story For Europe's Banks: The Final Push To Resolvability," published on Sept. 30, 2022 on RatingsDirect).

Additional Liquidity Assistance Comes With Strings Attached

The legislative proposal foresees several repercussions if a struggling or failed bank is granted an LAL, namely:

The bank will be required to reclaim variable compensation from current or former management.  This applies if the managers were directly or indirectly responsible for the circumstances that led to the bank needing the LAL.

The bank will be required to pay premiums and interest.  These payments comprise a provision premium to the federal government, a risk premium to the federal government and the SNB, as well as ordinary interest to the SNB. For example, under its existing borrowing agreement, Credit Suisse is required to pay interest equal to the SNB's current policy rate of 1.75% plus 0.5% for its ELA, 3% plus its policy rate for its ELA+, and a 3% risk premium split evenly between the central bank and the Swiss government for its LAL. In addition, Credit Suisse owes the Swiss government a 0.25% commitment premium for the provision of the LAL.

All loans under the backstop will be given the statutory bankruptcy privilege.  This means that the loans will be senior to all other bank debt, pari passu with insured deposits of up to CHF100,000, and junior to employee and pension fund claims.

Actions that could impair the bank's ability to repay the LAL are prohibited.   These prohibited actions include:

• Paying out dividends;
• Taking on new business;
• Undertaking organizational or restructuring measures; and
• Redeeming early or paying interest on hybrid capital instruments, the latter of which would lead to a default under our ratings' criteria even if no write-down was imposed.

The bank would be subject to increased supervision by FINMA.  FINMA will have the option of writing down additional hybrid capital instruments and dismissing management.

The Proposal Needs To Pass Several Legislative Hurdles

Following the conclusion of the consultation period on June 21, 2023, the authorities are assessing responses from cantons, political parties, and associations. Therefore, the content of the legislation could still change. September 2023 is the latest point at which the legislation must be passed due to the six-month window following enactment.

If parliament rejects the law, it could mean a partial roll-back of the measures that were applicable at the time of the Credit Suisse announcement. Consequently, covenants from the emergency ordinance that have not been turned into private law between Credit Suisse and SNB could become void. We do not expect that this would lead to a reinstatement of the AT1 instruments.

The Proposed Framework Differs Notably From Other Key Jurisdictions

Switzerland's current liquidity support framework has some features in common with frameworks in the U.S., Canada, Japan, the U.K., and the EU insofar as it offers collateralized liquidity under a gradated framework that moves from standard monetary operations, to a discount window, to nonstandard lending operations. However, the proposed magnitude of uncollateralized lending with public guarantees as well as the laid-down prerequisites of those support measures differ from other jurisdictions:

Japanese Deposit Insurance Corp.  Support is possible regardless of a bank's solvency.

The Bank of England (BOE).  The BOE is likely to seek government indemnity to cover material drawdowns from its resolution liquidity facility (RLF). Liquidity provided under the RLF may be secured against a wide range of collateral. The availability of uncollateralized funds is unclear.

The Canada Deposit Insurance Corp. and the European Single Resolution Fund.  These only allow uncollateralized lending in exceptional cases.

The U.S. Deposit Insurance Corp. and the Orderly Liquidity Fund.   These allow full collateralization.

The explicitness of the SFC's proposal to tie liquidity support--albeit extraordinary to the potential nonpayment of coupons or write-downs of hybrid capital instruments differs from approaches in other jurisdictions. This could be more far-reaching and consequential compared to the provisions in the other banking frameworks above. Some of these extraordinary facilities typically come with additional costs for the borrowing bank relative to borrowing in the standard discount window, and stressed banks might be subject to regulatory constraints due to their poor condition. In addition, the proposal's loss-bearing compensation mechanism differs from other jurisdictions' frameworks as the latter only stipulate an ex-post recoupment of losses from the banking industry.

Related Criteria

• Hybrid Capital: Methodology And Assumptions, March 2, 2022
• Financial Institutions Rating Methodology, Dec. 9, 2021

Related Research

• Research Update: Various Rating Actions Taken On Credit Suisse And UBS Group Entities After Merger Completion, June 12, 2023
• Credit FAQ: Asia-Pacific AT1 Hybrids Investors: Understanding The Credit Suisse Fallout, March 24, 2023
• Swiss Regulator's Statement On Credit Suisse AT1 Confirms Impact Of Documentation And Legislative Powers, March 23, 2023
• How The Composition Of Swiss Banks' Gone-Concern Buffers Affects Our Rating Metrics, April 4, 2023