Switzerland's central bank warned Swiss banks on Thursday that they still faced substantial risks for their profitability and their resilience in the event of a renewed financial dip.
The biggest Swiss banks, UBS and Credit Suisse, in particular are still vulnerable to uncertain financial markets, after credit prices rose again in the second quarter of this year, the Swiss National Bank said in its 2010 Financial Stability Report.
"The risks of big banks may, in particular, be judged as substantial when set in relation to their capacity to absorb losses," the report said.
While the banks have improved their capital buffers, their leverage remains high and "the margin for error that the big banks can afford remains narrow and any misjudgment of the risks could have serious consequences."
The SNB noted that the 2008 financial crisis was partly down to such misjudgements. The banks' ability to absorb losses is also harmed by their lower profit potential in the current economic climate and the likelihood of more difficult access to large amounts of additional capital in the event of trouble.
The report said the outlook for their profitability was "subdued" even with the recovery, with limited scope for high trading incomes.
It also questioned the ability of the big banks to sustain the revenues form investment banking they garnered in 2009, while private banking margins would be diminished with the weakening of banking secrecy.
If the currently expected economic recovery halted, the big banks could face "significant losses," the Swiss central bank warned.
Smaller Swiss banks with domestic focus do not face the same problems thanks to above average profitability, although they face greater credit market risks than last year, it added.
The SNB warned that even with a gradual economic recovery, with declining credit risk and more stable financial markets, banks would still face a "difficult environment," even though they should be able to cope with any losses on loans.
"Financial market conditions will be less favourable for the big banks than they were in 2009," the report said.
However, if there is a double dip recession and the recovery grinds to a halt, Swiss banking would face "a major challenge" with growing credit risk, falling asset prices, losses on loans and the inability of countries to maintain exceptional support measures.
"Consequently a substantial further strengthening of resilience as well as a conservative treatment of risk will be important at the big banks," the central bank's report said.