Switzerland
Financial Sector Assessment Program: Detailed Assessment of Observance of Financial Sector Standards and Codes

This paper discusses key findings of the detailed assessment of observance of financial sector standards and codes in Switzerland. Switzerland has a relatively unique banking sector, with a high market concentration by the two largest domestic banks. The overall assessment of the peer-review team is that Switzerland is generally in compliance with the Basel Core Principles with two exceptions where the Swiss Federal Banking Commission (SFBC) is deemed largely compliant. The two exception areas are budgetary independence and banking activities not subject to SFBC supervision.

Abstract

This paper discusses key findings of the detailed assessment of observance of financial sector standards and codes in Switzerland. Switzerland has a relatively unique banking sector, with a high market concentration by the two largest domestic banks. The overall assessment of the peer-review team is that Switzerland is generally in compliance with the Basel Core Principles with two exceptions where the Swiss Federal Banking Commission (SFBC) is deemed largely compliant. The two exception areas are budgetary independence and banking activities not subject to SFBC supervision.

I. Basel Core Principles for Effective Banking Supervision

This chapter provides the findings from the assessment of Basel Core Principles for Effective Banking Supervision (Basel Core Principles or BCP).1

Information and methodology used for assessment

The Swiss authorities were requested to complete a self-assessment questionnaire in advance of the mission pertaining to the above-mentioned regulatory standards and principles. The questionnaire and self-assessments, where performed, were made available to the peer group of experts in advance of the mission. During the mission, the responses to the questionnaire and self-assessments of compliance with the standards and principles were clarified and checked through subsequent discussion with the authorities and market participants in critical areas. In the case of the Basel Core Principles, the banking specialists reviewed documents made available in advance of the mission, met with host country supervisors in the United States and the United Kingdom of the largest two Swiss banks (the Credit Suisse Group and UBS), and spent several days interviewing representatives of the Swiss Federal Banking Commission (SFBC), bankers, bankers association representatives, and accountants in order to clarify and/or verify the facts contained in the questionnaire responses.

The responses to the IMF questionnaire by the Swiss authorities, detailed information available on the SFBC's Internet website (http://www.ebk.admin.ch/) plus the websites of KPMG Switzerland, the Swiss Bankers' Association (SBA), the Federal Department of Finance (FDF), and the two large Swiss banks, facilitated the initial drafting of this report. The Basel Core Principles assessors were able to focus their discussions and verify information provided with the Federal Law on Banks and Savings Banks of November 8, 1934 (Banking Act), as amended through April 22, 1999, the Ordinance of the Swiss Federal Council on Banks and Savings Banks of May 17, 1972 (Banking Ordinance), as amended through October 4, 1999, other ordinances and SFBC Circulars and Guidelines, Codes, Conventions and Agreements issued by the SBA. Implementing Swiss regulations, SFBC administrative notices and statutory instruments, audit and accounting guidelines and the SFBC's Guidelines on Financial Statement Reporting Requirements, which provide instructions/guidance for periodic financial and prudential reports, were incorporated into the assessment process. Follow-up questions were discussed with SFBC staff and supplemental information was provided to the banking specialists as necessary.

Institutional and macroprudential setting, market structure overview

Banking is one of the prime industries in the Swiss economy accounting for significant employment opportunities and contributing 11 percent to GDP. Bank activities have undergone changes in the last decade with reduction in bank savings accounts, increased investment funds, initiation of mortgage backed securities, increased global custody, fiduciary business, derivatives and investment counseling, and asset management business. Swiss banks offer global consultancy services, primarily in private banking that include tax, pension plan and inheritance counseling.

There are 375 banks licensed in Switzerland.2 The number of banks has been shrinking in the last decade due to increased competition, mergers and acquisitions. The banking sector is dominated by three large Swiss-licensed banks (part of two banking groups) with significant global presence. There are 24 cantonal banks, 103 regional banks, one cooperative bank (with 537 independent members), 17 private banks, 23 subsidiaries of major international financial conglomerates and 204 institutions categorized as “other banks.”

The two largest banking groups represent about 60 percent of total Swiss banks' assets and deposits and dominate the Swiss banking system. The spread of their operations into many different financial markets—including both banking and insurance—in many different countries, which resulted from an extended process of national and international mergers and acquisitions, has significantly complicated the establishment and management of their risk profile, both for their managements and supervisory boards, and for the supervisors. Recently, these large and complex financial institutions have been affected by turmoil on international financial markets. These two aspects–their increasing complexity and their sensitivity to international asset market developments–as well as their key role within the Swiss financial system underscore the importance of an intense, hands-on, and risk-based form of monitoring and supervision by the banking supervisor, including with regard to aspects of corporate governance in these large and often culturally diverse organizations.

The authority and responsibility of the SFBC in bank licensing and supervision are explicitly set out in the Banking Act and various ordinances, circulars, and guidelines. All credit institutions are subject to supervision and regulation by the SFBC. The SFBC is not responsible for the supervision of insurance companies, insurance intermediaries, investment advisors or industrial deposit-taking entities. Thus these entities are not included in this BCP assessment. However, recent recommendations issued by an expert working group include legislation to transfer the supervision of insurance intermediaries to the SFBC.

General preconditions for effective banking supervision

The SFBC and Swiss Government have achieved a high degree of implementation of the recommendations of the Basel Committee's reports. Although not a member of the European Union (EU), Switzerland has incorporated many of the EU Directives into its ordinances, guidelines and supervisory practices. To a large extent, the Basel Core Principles parallel the EU Directives and this contributed to Switzerland's compliance with the Basel Core Principles. The SFBC has recently taken steps to enhance its supervisory process by establishing a separate Large Bank Supervision unit to oversee the two large banking groups. The SFBC has also created a unit responsible for the assessment and validation of bank models. These two new units, focused primarily on the two main banks, have somewhat altered the traditional Swiss “indirect” supervision of these two banks. The changes allow the SFBC to better coordinate its supervisory activities for the two large banks with external auditors, bank management, foreign host supervisors, and the insurance supervisors. This approach shifts limited supervisory resources to the financial sector's greatest risk, that is, the largest banks. The risk-based supervision approach more fully integrates the SFBC's off-site analysis of these banks' prudential returns with the bank examinations performed by SFBC-licensed and approved external auditors. The new approach includes quarterly management meetings with the two institutions, semi-annual trilateral meetings with the U.K. and U.S. supervisors and the SFBC and annual trilateral meetings with the bank, its external auditor and the SFBC. Cooperation between the SFBC and the Swiss insurance supervisor has also been strengthened.

The overall assessment of the peer review team is that Switzerland is generally in compliance with the Basel Core Principles with two exceptions where the SFBC is deemed largely compliant. The two exceptions are in the area of budgetary independence and banking activities not subject to SFBC supervision. Both exceptions are discussed in more detail in the detailed assessment that follows. It is important to note that the assessment tailored the principles to the Swiss market. Switzerland has a relatively unique banking sector, with a high market concentration by the two largest domestic banks, and a relatively low level of complex bank activities conducted in most other banks, which are primarily involved with mortgage banking activities or private banking and asset management

Currently the SFBC—which is a small organization in comparison to the size of the system it oversees—relies heavily on the dualistic system of supervision whereby the on-site examinations are outsourced by the SFBC to approved and licensed external auditors. The supervisory process is enhanced by the self-regulatory activities of the industry via the Swiss Bankers Association (SBA) who, together with the SFBC issues guidance to the industry. The SFBC is aware of the risks of outsourcing on-site work and takes a number of steps to check that the work done meets the standards required. This dualistic approach, however, would benefit from a more formalized quality assurance program for supervising external auditors and an increase in joint on-site inspections. This, as well as preparations for the new Basel Capital Accord, will require the SFBC, among other things, to recruit and retain a sufficient number of additional competent staff. The SFBC is taking steps in this direction.

Frequent communication between the SFBC and the banks and the external auditors is key to the Swiss current supervisory process. The SFBC's licensing and supervisory policies and practices are clearly communicated to the banks and external auditors. As a member of the Basel Committee, the Joint Forum, and several other international standards and principle-setting bodies, the SFBC participates in setting the standards for financial sector supervision and actively strives to implement them.

The SFBC will continue to be challenged by innovative licensing proposals (such as Internet banks) and requests for approval of new business activities and increasingly complex investment products, many of the same issues being faced by supervisors in other financially developed countries. As banks expand or enter new businesses, supervisors need to remain vigilant in their supervision in order to minimize associated risks in the industry. This should include a more formalized system of supervision with more explicit supervisory directives being incorporated into the Banking Act. The SFBC is responding to recent regulatory initiatives put forth by various expert commissions and working groups to enhance the supervisory process. Several recommendations have come out of these projects and are being considered by the government as a good start in closing supervisory gaps among all financial companies.

Swiss legislation, SFBC ordinances and circulars, or SBA guidelines and circulars cover all the Basel Core Principles. Although the Banking Act is broad in some instances, the SFBC's implementation of the Banking Act through regulations and guidance to external auditors in their examination mandate reflects effective supervision and works well with the Swiss-licensed institutions.

Various expert commissions and working groups have been created in the last several years to analyze the Swiss financial system and supervision. In December 1998, Switzerland's Minister of Finance mandated an expert commission “Financial Market Supervision,” chaired by Prof. Zufferey, with an analysis of the strengths and weakness of the system for the supervision of the financial services industry in Switzerland. In November 2000, the expert commission issued a report and 42 general recommendations for a reform of the supervisory framework in the financial sector (“Bericht über die Finanzmarktregulierung und–aufsicht in der Schweiz,” Zufferey Report).

In May 1999, Switzerland's Finance Minister mandated an expert commission to review the existing bank reorganization and liquidation law and the deposit insurance system. In October 2000, the Expert Commission submitted its findings in a report along with a proposal for an amendment to the Banking Act. The trigger that started that reform process was the failure of the Spar and Leihkasse Thun in 1991, a large regional bank. This incident had brought several shortcomings of the existing legal framework for dealing with insolvent banks to the surface.

In February 2000, the SFBC mandated a working group, chaired by Prof. Nobel, with an analysis of the dualistic concept of the supervisory system. The working group published its report and 17 recommendations in December 2000. In March 2001, the working group “Auditing and Supervision of Banks” was established to follow up on those recommendations and put forward proposals to revise the Banking Act, the Banking Ordinance and the SFBC Circulars to implement the expert commission's recommendations.

In November 2001, the Federal Council instituted an Expert Commission with nine members that will be chaired by Prof. Zimmerli. The Expert Commission was mandated to put forward a legislative proposal for the creation of a unified financial supervisory authority. While the mission team was aware of the work of the various commissions and working groups, it was agreed prior to the start of the mission that the assessment of the Basel Core Principles would be done based on the laws, policies, and procedures in effect as of the start of the mission. This Basel Core Principles assessment arrived at many of the same conclusions as those of the commissions and working groups, and generally supports the various groups' recommendations.

At this time (and pending the revision of the Banking Act) a potential vulnerability exists because nonbank industrial deposit-taking entities and certain nonbank asset management/investment advisors are not under the SFBC's supervision or covered by the Basel Core Principles. There is vulnerability anytime non-regulated institutions compete with regulated institutions in banking-type activities.

Principle-by-principle assessment

The following assessment of the Basel Core Principles (BCP) is based on the Core Principles Methodology of the Basel Committee on Banking Supervision, October 1999. The methodology makes a distinction between “essential” and “additional” criteria. Essential criteria should be present in order for supervision to be considered effective. Additional criteria further strengthen supervision and countries should strive to implement as many of the additional criteria as possible. This assessment takes both the essential and additional criteria into consideration. Principle 15 on anti-money laundering supervisory activities was supplemented with the August 15, 2001 draft methodology paper issued by the IMF to further facilitate assessments of this particular area and a separate report on anti-money laundering efforts was prepared.

The Basel Core Principles are grouped into seven categories: (1) Preconditions for Effective Banking Supervision; (2) Licensing and Structure; (3) Prudential Regulations and Requirements; (4) Methods of Ongoing Banking Supervision; (5) Information Requirements; (6) Formal Powers of Supervisors; and, (7) Cross-Border Banking.

Table 1.

Detailed Assessment of Compliance with the Basel Core Principles

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Table 2.

Summary Compliance with the Basel Core Principles

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C: Compliant.

LC: Largely compliant.

MNC: Materially non-compliant.

NC: Non-compliant.

NA: Not applicable.

Recommended action plan and authorities' response to the assessment

Table 3.

Recommended Action Plan—Basel Core Principles

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Authorities' response

In general, the Swiss authorities agreed with the main findings and the recommendations, in particular CP 1.2 (budgetary independence) and CP 2 (deposit taking entities). Most comments of the SFBC were included in the assessment. The main area in which the mission team identified a need for improvement and where agreement with the Swiss authorities was not fully reached is detailed below.

  • CP 1.6/24: The SFBC shares the conviction that it is important to establish a relationship with other primary supervisors. As mentioned earlier, the existence of a formal co-operation arrangement with a foreign regulator is not a prerequisite for the exchange of information under Swiss law. While the existence of such arrangements may be useful in some cases, the SFBC finds that in the absence of such arrangements co-operation can be as efficient and oftentimes more flexible. There are no legal or other obstacles for the SFBC to enter into formal co-operation arrangements with a foreign counterpart. Should a foreign regulator, with whom the SFBC maintains close working relations, wish to formalize this process the SFBC does not raise any objections.

II. IOSCO Objectives and Principles of Securities Regulation

This report was prepared as part of the Financial Sector Assessment Program (FSAP) of Switzerland. Its purpose is to assess implementation of the IOSCO Objectives and Principles of Securities Regulation.

An IMF mission visited Switzerland in October 2001 to conduct the assessment. The mission met with staff of the Swiss National Bank (SNB), the Swiss Federal Banking Commission (SFBC), the Swiss Exchange (SWX), the Swiss Funds Association, and several private sector firms. The assessment contained in this report is based on these discussions, on the responses to questionnaires sent to the SFBC, and on the analysis of relevant laws, regulations, administrative polices and other written information provided during the meetings.4

Institutional Setting and Market Structure

Supervision and regulation of the securities market are entrusted to the SFBC. The SFBC is responsible for licensing and supervising securities dealers and stock exchanges; it regulates disclosure of shareholdings in listed companies and takeover bids. Supervisory functions are also delegated to the exchanges, which function as SROs and supervise trading, exchange members and listing procedures.

As with the supervision of banks, the SFBC relies on recognized private external auditors to conduct front-line supervision and has not performed on-site inspections of securities dealers in the recent past. Front-line supervision of the SWX is also performed by an external auditor. The auditor is required to examine compliance with the obligations arising from the Stock Exchange Act, the implementing ordinance, and the relevant rules and regulations.

The SWX, as an SRO, is responsible for regulating its members and admitting participants to trading (who have to be licensed securities dealers); supervising price formation, execution and settlement of transactions; and ensuring that the information necessary “to maintain a transparent market” is made public. The Exchange is also responsible for enforcing listing rules and checking listing prospectuses.

In 2000, the SWX ranked 10th in the world by turnover in equities, with turnover of SwF1.0 trillion, more than double the turnover in 1996. Market capitalization of the Swiss Performance Index (SPI) was SwF 1.3 trillion at the end of 2000 (equivalent to three times annual GDP). Since June 2001, the stocks represented in the Swiss blue chip index (SMI) are being traded exclusively on Virt-x—the new pan-European blue chip exchange in London, which is a joint venture between the SWX and Tradepoint. The SWX is also one of the largest markets for warrants in the world with almost 3500 warrants listed. Since 1998, all Swiss standardized derivatives are traded on EUREX, which was created by the merger of the Swiss Options and Financial Futures Exchange (SOFFEX) with the Deutsche Terminbörse (DTB).

Securities intermediaries comprise primarily securities dealers and investment funds.5 Since the Swiss system is based on the universal bank model, both the securities and the fund businesses are dominated by banks. Total assets of investment funds have almost doubled since 1996 to SwF 468 billion (115 percent of GDP) at end-2000. More than two-thirds of the assets are invested in foreign funds, which are in most cases established by Swiss financial institutions in Luxembourg and their products are then offered in Switzerland to residents and nonresidents.

Principle-by-Principle Assessment

This section presents a detailed discussion and assessment of practices in Switzerland regarding securities regulation, vis-à-vis the practices in the IOSCO Objectives and Principles of Securities Regulation. The assessment of observance of each practice is made on a qualitative basis using a four-part assessment system: implemented; partially implemented; non-implemented; not applicable.

A Principle will be considered implemented whenever all assessment criteria are met without any material deficiencies. It will be considered partially implemented when the authorities have not fully implemented one or more assessment criteria. A Principle will be considered non-implemented whenever material shortcomings are found in adhering to the assessment criteria. When a principle is assessed to be partially or non-implemented, recommendations are provided to improve observance. A Principle will be considered not applicable whenever it does not apply given the existing structural and institutional conditions.

Table 4.

Detailed Assessment of Observance of the IOSCO Objectives and Principles

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