The Ethos Foundation welcomes and supports the amendments proposed by the Swiss Federal Council to the bank capital and liquidity ordinances. However, Ethos considers that the additional tier 1 capital (AT1) reform remains incomplete. Ethos calls on the Federal Council to further review the regulations and to examine alternatives, including the removal of AT1 instruments.
Ethos supports the measures proposed by the Federal Council to strengthen the resilience of large banks and the financial system, particularly those aimed at increasing the quantity and quality of capital and liquidity of systemic institutions. Ethos is publishing today its position paper (in French or German) as part of the consultation process on amendments to the Capital Adequacy Ordinance and the Liquidity Ordinance for Banks, currently being conducted by the Swiss Federal Department of Finance.
These regulatory amendments are a first step in the reform process initiated in the wake of the crisis and the demise of Credit Suisse. In line with its long-standing commitment, Ethos is calling for the strengthening of high-quality capital, both at the regulatory level and as a shareholder and representative of shareholders of systemically important banks. Such a strengthening would make a decisive contribution to preventing future crises.
Reservations about AT1 instruments
Nevertheless, Ethos has reservations about the design of the additional capital, known as Additional Tier 1 (AT1) instruments. Designed to serve as protection in the event of a bank's financial distress – through write-downs or conversion into shares – these instruments present risks that the Federal Council's proposal does not adequately address.
In its report published in December 2024, the Parliamentary Commission of Inquiry into the Credit Suisse crisis emphasised that it was ‘essential to critically examine the function of AT1 instruments and, if necessary, to adapt the relevant legislation’.
A bad signal and the risk of a self-fulfilling prophecy
In its proposal, the Federal Council does not address the fundamental risks associated with AT1 instruments. However, the effectiveness of these instruments in ensuring the continued operation of a bank (going concern) remains uncertain. There is even a real risk that using such instruments could accelerate the difficulties encountered by a bank.
Suspension of the coupon, amortisation or conversion of these instruments into shares - triggered at certain conditions or at the request of the authorities – could cause a crisis of confidence. This could lead to massive deposit withdrawals and securities sales on the financial markets, further aggravating the liquidity crisis. The bankruptcy of Credit Suisse in March 2023 demonstrated how quickly such a loss of confidence can weaken a bank. This runs counter to the objective of these AT1 instruments implemented by the draft ordinance, which aims to stabilise the bank so that it can continue its activities.
From an institutional investor’s perspective, these instruments can offer more attractive returns than traditional bonds, particularly in a low-interest rate environment. However, their risk profile should be considered more similar to that of non-voting shares. Thus, the bond asset class is potentially diluted in a non-transparent manner by products similar to equities. Some Swiss pension funds only discovered the presence of Credit Suisse AT1 bonds in their portfolios when the crisis hit and these securities were written down entirely.
Ethos recommendations
Ethos calls on the Federal Council to thoroughly review the regulations on additional capital for systemic banks. In particular, it should consider alternatives to AT1 instruments, including abolishing them and replacing them with core tier 1capital.
At the same time, the Federal Council should mandate the Federal Department of Finance to advance discussions on AT1 reform internationally.
