Is the Zürcker Kantonalbank (ZKB) really «Too big to fail»?

In the summer of 2008, as a consequence of the events of Freddie Mac, Bern Sterns and Lehman Brothers, a new concept broke out on economics supplements: “Too big to fail”. This new concept defines the threshold from which a financial institution is so large that one hypothetical bankrupcy might bring down the whole economy with it as well. These kind of institutions, also named “Systemically financial institutions” (SIFI) have been addressed specifically on the new Basel III framework. The focus of the new developments has been to raise bank capital requirements and to establish capital surcharges for these SIFIs . The BIS Committee (through the Financial Stability board) also released a closed list of these SIFIs (see here), in which are the two big Swiss banks.
However, last month, the SNB announced that Zürcher Kantonalbank (ZKB), the country’s biggest cantonal bank, also represents a systemic risk to the country’s financial system (See here). Why has SNB taken such decision? What does it mean?

20131204_ZKB

I guess Swiss financial authorities are very confident about their new “Too big to fail regulation”, one of the most demanding law on the world, and therefore want to extend their use. This is certainly a laudable objective but, at this point, it is important to bear in mind that whatever new regulation creates hidden incentives which authorities also should take on board.
On one hand, it is clear that from now on, ZKB will be subject to transparent conditions and harder supervision. For instance, it must meet a capital surcharge. However, on the other hand, being a systemically Institution is a powerful signal for creditors. In some way, they know that from now on, are the all Swiss taxpayers who jointly liable the ZKB financial obligations.

In my opinion, this lack of market discipline has been one of elements which have most destabilized the financial markets during last 20 years. Ben Bernake already pointed out in 2009 this circumstance as one of the causes of financial crisis . «If creditors believe that an institution will not be allowed to fail, they will not demand as much compensation for risks as they otherwise would, (…) As a result, too-big-to-fail firms will tend to take more risk than desirable, (…)»
Have a quick look to main figures of ZKB.

  Swiss IA banks
(CHF, bn)
UBS
(CHF, ml)
Credit Suisse
 (CHF, ml)
Zucker Kantonalbank (ZKB)
 (CHF, ml)
Assets 3182 1259797 924280 150694
 Tier 1 ratio 15,38% 9,76% 14,89% 15,23%
Density RWA 25,96% 20,49% 31,64% 38,60%
Capital Total assets 3,99% 2,00% 4,71% 5,88%
Assets / GDP Switzerland 5,52 2,18 1,60 0,26
Market Share 39,59% 29,05% 4,74%

As we can see on table above, ZKB doesn’t seem a huge institution able to bring down the whole Swiss economy. ZKB focuses their business on Zurich area and, although it has got a big wealth management business branch, its main expertise is retail banking. Moreover, so far, it has a strong capitalization, substantially higher than its Swiss SIFIs peers. In short, it seems that ZKB is not too big and besides, it has been doing it well up to now. And then, why has SNB announced that it is “too big to fail”?

I don’t understand it. Even though ZKB must meet harder requirements in the short term, the benefits in the long-haul outweigh the initial drawbacks. ZKB’s creditors will slow down their demands and step by step, ZKB will cut down its financial cost, and as a result, it would be likely to take more risk that it should. Financial analysts must keep an eye on such possible evolution.

Finally, always it’s interesting to remember that this kind of public financial support is, in essence, a transfer of public money from taxpayers to ZKB owner’s pocket. In this case, ZKB is a public institution, but UBS and Credit Suisse not.