Switzerland: Staff Report for the 2014 Article IV Consultation

This 2014 Article IV Consultation outlines that the growth of the Swiss economy has gathered pace, but inflation remains close to zero. The recovery is expected to continue and inflation should rise gradually although the output gap will progressively close. The fiscal position is healthy, with a broadly neutral stance projected for 2014. Despite improved market confidence toward the euro area and tapering in the United States, the exchange rate has remained close to the floor. The authorities have taken several measures to contain risks, including raising the countercyclical capital buffer and adopting prudential measures to tighten lending standards and conditions.


This 2014 Article IV Consultation outlines that the growth of the Swiss economy has gathered pace, but inflation remains close to zero. The recovery is expected to continue and inflation should rise gradually although the output gap will progressively close. The fiscal position is healthy, with a broadly neutral stance projected for 2014. Despite improved market confidence toward the euro area and tapering in the United States, the exchange rate has remained close to the floor. The authorities have taken several measures to contain risks, including raising the countercyclical capital buffer and adopting prudential measures to tighten lending standards and conditions.


1. The Swiss economy has regained momentum, but monetary and exchange rate conditions have not normalized. While growth is healthy and the pass-through from past appreciation has mostly run its course, inflation is still only barely positive. Though no foreign exchange market intervention has taken place since 2012, the currency has remained close to the floor imposed by the Swiss National Bank (SNB) in 2011 to contain deflationary pressures, notwithstanding improved market confidence toward the euro area and tapering in the United States. With the policy rate at zero and abundant excess liquidity, imbalances in the mortgage market continue to build though at a somewhat slower pace than last year.

2. In the medium term, aspects of the current economic model will be questioned. The role of Switzerland as a center for global wealth management is being challenged by the progressive erosion of bank secrecy. Under international pressure, the authorities need to reform parts of the current system of corporate taxation, which de facto give favorable tax treatment to income from foreign operations and have helped attract many multinational corporations. A recent popular vote approved curbs on immigration, putting in jeopardy the free movement of labor agreement and, possibly, broader cooperation agreements with the European Union (EU), by far Switzerland’s largest trading partner. Lower immigration would also accelerate population aging.

3. The large banking sector is resilient and considerable regulatory reforms have been implemented after the crisis. The size and reach of the financial sector extend well beyond the Swiss borders, as the country is host to some of the largest and most globalized banks and insurance companies in the world. The 2014 FSAP Update finds that the position of the financial sector has improved markedly since the Global Financial Crisis, and recommends additional measures to strengthen the regulatory framework, prudential oversight, and the safety net to further improve the soundness and resilience of the system.

Recent Economic Developments and Outlook

A. GDP Growth Has Accelerated and Inflation Is Still Close to Zero

4. Driven by domestic demand, the economy grew briskly in 2013. Output expanded at 2.0 percent in 2013, up from 1 percent in 2012 (Figure 1). Private consumption continued to grow steadily as wage increases and negative inflation raised real disposable income; construction saw a strong rebound, while an improving external environment turned the external sector’s contribution to growth to positive. The lagged effects of the 2012 slowdown pushed the unemployment rate up to 3.2 percent, still low in international comparison. Labor supply was boosted by net immigration of some 1 percent of the population, the highest since 2008.

Figure 1.
Figure 1.

Switzerland: Recent Economic Developments

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: Haver Analytics; Swiss National Bank; and IMF estimates.

5. After two years of deflation, price growth is hovering around zero. As the pass-through from past exchange rate appreciation has abated, negative inflation from foreign goods and services has been offset by positive inflation from domestic goods and services. Inflation expectations (measured by consensus forecasts) have come down somewhat but are still well anchored in positive territory.

6. A significant and sustained net reversal of safe haven capital inflows has not occurred, including because of intermittent waves of global financial turbulence. The reduction in euro area tail risks, accompanied by nascent signs of a Europe-wide recovery, allowed the franc to trade in a 1.22–1.25 band relative to the euro during July 2012–April 2013, somewhat above the 1.2 floor. However, since then, global volatility surges around the announced and actual normalization of U.S. monetary policy, as well as recent EM turmoil and market jitters related to the political crisis in Ukraine, saw the franc appreciate against the euro and trade closer to the floor once again (Annex 1 and Figure 2). The SNB’s balance sheet has remained elevated at around 80 percent of GDP, well above levels observed for other advanced economies with the exception of Hong Kong and Singapore.

Figure 2.
Figure 2.

Switzerland: Monetary and Exchange Rate Policies

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: CFTC; Haver Analytics; Information Notice System; OECD; Swiss National Bank; and IMF staff estimates.

CHF/EUR appreciation since April 2013

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

B. Pressures in the Housing Market Are Proving Difficult to Contain

7. The banking sector is exhibiting divergent trends. The balance sheets of the two large banks continue to shrink as the banks strive to meet new regulatory requirements. Meanwhile, domestically-oriented banks have grown substantially, fuelled by increases in real estate lending, and becoming increasingly exposed to a possible sharp price correction and higher interest rates. Overall, the banking sector appears well capitalized and profitable.

8. Expansionary monetary policy and ample liquidity have pushed mortgage debt and real estate prices to historic heights. Residential real estate prices have been growing faster than income, with prices of owner occupied apartments rising at 6 percent per year on average since 2008. In real terms, these prices are now above the peak reached in the early 1990s, which was followed by a sharp correction. In some areas such as Geneva, price growth has been substantially higher. In parallel, growth of about 5 percent per year since 2009 has brought mortgage debt above 140 percent of GDP at end-2013, a historic peak. The average mortgage maturity is relatively short (about 5 years), and mortgages are often rolled over at maturity. This exposes highly indebted households to potential interest rate hikes in the future. High mortgage growth in the buy-to-let sector is a source of concern. On the other hand, non-mortgage lending to corporations has remained subdued and there are no indications of stretched corporate balance sheets, with default rates and credit ratings stable.


Mortages by Type of Borrower

(Year-on-year, percent)

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Source: Swiss National Bank.

Real Residential Real Estate Prices


Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: Wuest&Partner; and IMF’s International Financial Statistics.

C. The Fiscal Deficit and Debt Are Low

9. Anchored in strong fiscal rules and discipline, the fiscal position is healthy. The general government’s budget was close to balance in 2013, as small deficits at the federal and cantonal level were offset by a surplus in the social security funds. The federal balance deteriorated somewhat relative to 2012 because of higher subsidies, grants, and social benefits, but deficits in cantons and municipalities were reduced from the previous year. Previous reforms to unemployment insurance and a VAT increase earmarked for invalidity pensions allowed the social security funds to remain in surplus.

10. In 2014, the fiscal stance is expected to be broadly neutral. The general government should record a small deficit largely reflecting the lack of a profit distribution from the SNB and one-off restructuring contributions towards cantonal pension funds. Going forward, cantonal finances will be under some pressure because of the continuing need to raise the funding ratio of cantonal pension funds and changes in the hospital financing scheme. In addition, the corporate tax reform which is envisaged to enter into force as of 2018 is likely to lead to a revenue loss for cantons (see below). To prepare for the potential revenue loss as part of the burden sharing agreement with cantons, the federal government plans to restrain spending and implement a consolidation package. All in all, the structural balance should remain close to zero beyond 2014, with deficits at the cantons and communes level offset by surpluses in the federal government and social security funds. The debt-to-GDP ratio should fall to 44 percent of GDP in 2017 (on a GFSM-basis). From a medium-term perspective, spending pressures will arise from population aging and peak at about 4 percent of GDP by 2055.

Outlook and Risks

11. The recovery is expected to be robust. Looking ahead, in the baseline scenario recovering external demand and a stable exchange rate will provide impetus to exports and investment, while private consumption growth will moderate somewhat in line with modest real wage developments. The economy should grow at 2.1 percent in 2014 and 2.2 percent in 2015, while inflation should continue to rise gradually and the output gap will progressively close.

12. Risks to the outlook stem from spillovers from international developments, the domestic mortgage market, and the large financial sector.1 A strengthening in the global recovery would bring positive spillovers through higher external demand. Negative spillovers might arise if exit from UMP is disorderly and causes surges in global market volatility, leading to renewed safe haven inflows and forcing the SNB to intervene again. Protracted turmoil in emerging markets might also rekindle the attractiveness of Switzerland as a safe haven, as might a re-emergence of financial stress in the euro area because of significant policy slippages or adverse economic shocks.

13. A domestic source of risk is the mortgage market, where imbalances have been building since 2007 though at a slower pace than in typical housing bubble episodes (Figure 3). Domestically-oriented banks are especially vulnerable given their high and relatively undiversified exposure to domestic mortgages. Stress tests performed in the FSAP Update found these banks to be well capitalized under all scenarios, including a housing crash scenario. However, the analysis was limited by the lack of access to supervisory data on individual banks, and hence could not assess individual bank vulnerabilities.

Figure 3.
Figure 3.

House Price Indicators During Boom and Bust Episodes in OECD Countries

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: OECD; SFSO; Wuest & Partner; and IMF staff calculations.

14. In addition, despite progress the two large banks remain highly leveraged and interconnected. FSAP stress tests indicate that these banks comfortably exceed capital requirements under all adverse scenarios when applying the phase-in of Basel III rules, but under the most severe macroeconomic scenario capital ratios could fall below the 7 percent threshold under a fully implemented Basel III capital definition.2 As the banks are globally interconnected, they are a potential source of outward spillovers and vulnerable to inward spillover from instability in global financial markets. The FSAP analysis finds that these risks are contained at the moment, and outward adverse spillovers measured as the contribution of the Swiss large banks to the vulnerability of other global banks have decreased significantly in recent months.3 Possible financial-sovereign spillovers are also a concern given the large size of the financial sector relative to the economy. In addition, some cantonal banks have explicit funding guarantees and are large relative to the cantonal economy. Stress tests conducted as part of the FSAP indicate that existing capital buffers in the banking sector should be sufficient to absorb losses from severe macroeconomic shocks, suggesting limited fiscal contingent liabilities. The FSAP analysis also finds that contagion from banks to sovereign seems contained at present, owing to stronger capital buffers, fading concerns about tail events in the euro zone, and lower risk aversion among investors. Concerning the risk of illiquidity, almost all banks satisfy the LCR requirement thanks in part to the unusually high amount of deposits at the central bank.

The authorities’ view

15. The authorities were more sanguine than staff on the baseline scenario, but agreed about the main risk factors. Growth forecasts were aligned for 2014, but a stronger acceleration was envisaged in 2015. The authorities agreed with staff that growth prospects are subject to considerable uncertainty in light of economic developments in the euro area and emerging markets against the backdrop of exit from the unconventional monetary policies in major advanced economies.

Policy Discussions

A. External Sector Assessment

16. Overall, the Swiss current account surplus remained large in 2013, but its exact size will not be known until later in the year (Figure 4). Preliminary estimates of the current account balance for 2013 indicate a surplus of 13 percent of GDP, a 3.4 percent of GDP increase over 2012. The goods balance improved slightly, consistent with a resumption of the post-crisis increase in Switzerland’s share of the emerging and developing economies’ market, but this was offset by softer services exports (including merchanting receipts). The bulk of the current account increase is accounted for by net investment income, which is highly volatile and subject to large downward revisions (averaging 5 percent of GDP over the last two years). To reflect likely downward revisions, staff estimates a current account surplus of around 9½ percent of GDP for 2013.

Figure 4.
Figure 4.

Switzerland: External Account and Related Peculiarities

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: Haver Analytics; IMF’s Balance of Payments Statistics; and IMF staff calculations.1/ Merchanting is defined as the purchase of goods by a resident (of the compiling economy) from a nonresident combined with the subsequentresale of the same goods to another nonresident without the goods being present in the compiling

Share of Switzerland in Total Goods Imports by Country Group (Percent)

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Source: Direction of Trade Statistics.1/ Q1-3 2013.

17. While the assessment remains difficult due to accounting and other anomalies, staff views the current account as broadly in line with fundamentals. Model-based analysis suggests that a large the current account surplus is consistent with Switzerland’s high per capita income, financial center structure, and demographics. In addition, no distortions that would result in excessive saving or insufficient investment are evident, and, as noted in past consultations, the surplus is somewhat larger than the norm, but this divergence can be accounted for by various anomalies that tend to overstate the surplus. For instance, merchant services, i.e. services by international commodity trading companies based in Switzerland, have become important over the last decade, contributing around 3 percent of GDP to the current account surplus in recent years, though some of these companies have only limited activities in Switzerland. Second, Swiss multinationals firms are often partly owned by foreigners through portfolio shares. Thus, a part of the retained earnings of these companies, which form a large component of Swiss current account receipts, should be attributed to foreign shareholders, rather than counted as domestic income. Third, cross-border shopping, i.e. direct purchases by households while abroad or mail/courier deliveries from abroad, may not be fully reflected in imports. Finally, Switzerland, like other low-tax financial centers that host large multinational corporations and their affiliates, is susceptible to attempts by those firms to minimize their taxes by booking profits in the country, which would result in inflated net exports. However, quantifying this factor is not possible for now.

18. The franc still remains moderately over-valued, reflecting the legacy of the large real appreciation during 2008–11. The assessment reflects the estimated 7 percent overvaluation according to the External Balance Assessment methodology, broadly unchanged since last year. The REER-ULC has appreciated by 2.6 percent since end-2012, and cumulatively by 1.3 percent since end-September 2011 (i.e. the first “post-floor” month). With negative inflation differentials vis-à-vis trading partners disappearing and the nominal exchange rate appreciating in line with the appreciation of the euro over the last 12 months, the over-valuation is no longer correcting itself. On the other hand, this moderate overvaluation is no longer having a significant negative effect on overall external sector performance. If safe haven flows reverse as the crisis effects wane, the real exchange rate overvaluation should reverse.

The authorities’ view

19. The authorities broadly concurred with staff’s assessment of the current account and real exchange rate. They agreed that movements in the Swiss current account—due to its special structure and the various anomalies affecting it—were difficult to interpret and compare with global norms, and did not necessarily mirror developments in the real exchange rate. They also noted that the current account statistics will change substantially with the adoption (in June 2014) of the BPM6 methodology. The authorities’ stress that depending on the estimation methodology, the franc’s overvaluation, which they saw as still burdensome for the export-oriented manufacturing sector, may be larger than the 7 percent IMF assessment.

B. Monetary and Exchange Rate Policies

20. Domestic macroeconomic conditions do not call for a monetary tightening yet and the risk of resumption in safe haven inflows remains considerable. Although both core and headline inflation turned slightly positive at end-2013, the recent inflation decline in other advanced economies and especially the euro area is exerting downward pressures on prices. Also, with the internationally open labor market stronger domestic activity may not result in wage and price pressures (though future curbs on immigration may change this in the medium term), while the money multiplier remains very low. On the other hand, sizable risks remain of renewed pressures on the franc through a return of safe haven inflows triggered by external events (see Para. 12). Without the floor, such pressures would translate in a sharp nominal appreciation and a return of deflation.

21. The floor should remain in place for now to guard against deflationary risks. Going forward, an appropriate strategy should balance the need to keep inflation expectations well anchored against the risk of an excessive tightening of monetary conditions through renewed exchange rate appreciation. Achieving this objective will require careful calibration of unconventional policy instruments.

  • In an upside scenario, where the global recovery takes hold and confidence in the euro area solidifies, past safe haven flows would revert, potentially pushing the franc well above the floor. In this scenario, concerns about deflation would be muted, so there would be no need for a large depreciation to drive up inflation. A large depreciation would also be questionable from a multilateral perspective given the balanced external position. Thus, in this scenario the SNB should gradually reduce its holdings of foreign exchange reserves, supporting this strategy with clear communication to avoid market disruption and adverse outward spillovers. As the recovery takes hold, if inflation threatens to move above comfortable levels, then the SNB should raise the policy rate. This may become necessary even if the balance sheet has not returned to its precrisis level.

  • In a more challenging global environment, where exit from UMP by major advanced countries is disorderly, downside risks to the euro area materialize, or the EM sell-off develops into a full-blown crisis, safe haven inflows may return and a premature exit from the floor would likely result in a sharp appreciation and renewed deflationary pressures. In this scenario, the SNB should keep the floor in place and consider imposing a negative interest rate on bank excess reserves to discourage inflows.

  • Negative interest rates might also help address deflationary pressures that may arise from adverse domestic shocks. The impact of negative rates on the economy would need to be carefully monitored, and macroprudential measures may have to be reinforced to prevent an exacerbation of mortgage market imbalances.

22. Risks from the large SNB balance sheet need to be mitigated. These risks were recently underscored as the SNB announced a sizable valuation loss on gold holdings, triggering the first suspension of profit transfers to the Confederation and cantons in recent memory. While the build-up of risk provision was stepped up in 2011, it has not kept pace with the increase in the balance sheet. Going forward, provisioning should receive priority over transfers to the distribution reserve.4

The authorities’ view

23. The SNB continues to see the exchange rate floor as essential to guarding against the risk of deflation. It noted the recent multiple downward revisions to its inflation forecast, attributing them to weaker euro area inflation and a very protracted pass-through from past appreciation. The SNB agreed that negative interest rates on banks’ excess reserves were a possible tool to be deployed if safe have inflows resumed on a significant scale. With regard to the management of its balance sheet and associated risks, the SNB viewed current profit distribution arrangements as sufficiently protective of its capital.

C. The Housing Market

24. Despite measures taken by the authorities, risks in the mortgage and housing markets continue to build. To address growing imbalances, in 2012 and 2013, the authorities tightened lending requirements and increased banks’ capital buffers for mortgage risk (Box 1), but the effects appear to have been small so far. House price increases have slowed down somewhat, as prices for owner occupied apartments, which had grown by about 6 percent per year on average since 2008, grew at 4.3 percent (year-on-year) in the second half of 2013. However, limited cooling off effects can be seen in mortgage lending growth (where mortgages to buy-to-let companies accelerated in 2012–13), or in quantitative lending standards.

Measures to Address Developments in the Housing and Mortgage Market

New minimum requirements drawn up by the Swiss Bankers Association recognized by FINMA, effective mid-2012:

  • Down payment of 10 percent of the lending value of the property from the borrower’s own funds, which may not be obtained by pledging or early withdrawal of Pillar 2 pension assets;

  • Mortgages must be paid down to two thirds of the collateral value within a maximum of 20 years.

FINMA tightened rules for risk-weighting new and renewed mortgages for banks applying an internal ratings-based approach, effective 2013.

Federal Council measures, effective 2013:

  • Mortgages that do not comply with the new minimum standards are allowed, but subject to a risk weight of 100 percent;

  • Mortgages exceeding 80 percent of the property value will have a risk weight of 100 percent applied to the part of the loan exceeding the 80 percent threshold.

On SNB’s proposal, the Federal Council activated the Counter Cyclical Capital Buffer (CCB). The CCB applies to risk-weighted positions associated to residential property mortgages in Switzerland. The CCB was activated to a level of 1 percent CET1 capital by end–September, 2013 and raised to 2 percent in January 2014 (to be fulfilled by end-June, 2014).

25. The measures taken to address developments in the mortgage and housing markets are welcome, but have been only partially successful. The recent CCB hike was appropriate, but its impact may not be sufficient given the comfortable capitalization relative to prudential requirements across the domestically oriented banking sector. In addition, existing self-regulation measures have not been very effective as quantitative lending surveys show no or limited reduction in debt-to-income ratios (DTIs) or loan-to-value ratios (LTVs). Although the household sector has substantial financial assets, data on the distribution of wealth and mortgage debt across households are not available, so there are concerns that vulnerable households may be taking on excessive debt.

26. Direct regulatory measures targeting affordability and loan-to-value ratios should also be considered. In an environment where interest rates are likely to remain very low, stronger measures targeting mortgage demand are needed. If agreement with the industry to tighten self-regulation (in particular, faster amortization and larger cash down payments) cannot be achieved, then it would be important to introduce direct regulation on maximum DTIs and LTVs.5 Parallel measures to curb mortgages to income-producing real estate companies should also be put in place, while supervisors should continue to use Pillar II measures pro-actively to address concentration and interest rates risks. In addition, tax deductibility of mortgage interest should be reduced or eliminated.

The authorities’ view

27. The authorities agree that imbalances have continued to expand though they consider that the measures taken have had some calming effects. Continued concerns were behind the recent decision to increase the CCB. The authorities also agreed on the need for further action targeting the demand side and informed that measures on affordability were under discussion, including with respect to the buy-to-let segment. If appropriately tight measures could not be implemented through self-regulation, direct regulation was an option. On the other hand, political support for a reform of the taxation of mortgage interest was seen as elusive.

D. Financial Stability and Oversight

The TBTF Banks and Cross-Border Resolution

28. The two large banks continue to strengthen capitalization and restructure their business models, but the leverage ratios remains low compared to other large global banks. In 2012, both banks stepped up their plans to build high-quality capital, and initiated strategic restructuring away from parts of investment banking to less capital-intensive wealth management. The banks are also revising their corporate structure, operations, and business lines to adapt to the still evolving new regulatory landscape, especially in the U.S. and the U.K., where they have important activities, and divergent approaches by regulators are an obstacle to the global management of liquidity and capital. At end-2013 both banks were already above the 10 percent minimum CET1 capital ratio in the Swiss Too-Big-Too-Fail (TBTF) legislation to be met by 2019. The progress in increasing the leverage ratio, however, has been slower; both banks are below the fully-implemented Swiss minimum leverage ratio and lag behind most other large global banks based on other leverage measures (Figure 5). On the other hand, the liquidity position is strong, with the Basel III Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) exceeded at end-2013. Both banks were profitable in 2013, but potential costs from various legal risks (e.g. mortgage mis-selling and aiding tax evasion in the United States, illegal trading activity in LIBOR and foreign exchange markets) weighed on the results.

Figure 5.
Figure 5.

Switzerland: Systemic Bank Indicators*

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: Bankscope; Bloomberg; and IMF staff calculations.*/ “Other”includes Citigroup, Deutsche Bank, HSBC, JP Morgan Chase, Barclays, BNP, Bank of America, New York Mellon, Goldman Sachs, Mitsubishi, Morgan Stanley, Royal Bank of Scotland, Bank of China, BBVA, BPCE, Crédit Agricole, ING, Mizuho, Nordea, Santander, Société Générale, Standard Chartered, State Street, Sumitomo, UniCredit, Wells Fargo, Commerzbank, Dexia, Lloyds.

29. Given the special risks posed by their size, the two large banks should rapidly bring their leverage ratio in line with that of other major international banks. In light of the size of the two large banks relative to the economy, the authorities should ensure that minimum requirements in terms of leverage are more ambitious than minimum international standards both in terms of level and of the quality of capital. For the large banks, the current Swiss total capital leverage ratio minimum is above the envisaged 3 percent Basel. However, a substantial portion of the Swiss requirement can be held as CoCos, which are not necessarily Tier 1 capital. In addition, the ongoing examination by FINMA of how risk-weights in internal models differ from those under the standard approach is welcome, and model approval decisions should be reviewed in cases where such differences are large. In this context, FINMA should be commended for demanding higher risk weighted assets for operational risk from the two large banks.

30. Making the TBTF resolution regime robust and workable cross-border should be a priority to ensure financial and economic stability. Work should continue with the banks and key host authorities to finalize a viable strategy that would make the largest banks resolvable without government support. Reaching a cooperation agreement with the U.S. and U.K. authorities, the two key jurisdictions for the Swiss TBTF banks, would be a very welcome achievement.

The authorities’ view

31. The authorities emphasized that capital regulation will remain tighter than international standards. On the regulatory leverage ratio, the authorities noted that Switzerland is ahead of the field as it already has a minimum leverage ratio in place. It was furthermore noted that as the Basel III definition of leverage is finalized, it will be ensured that the objective of having tougher rules than international minimum standards will be met. The authorities confirmed that they are actively working with, the U.K. and U.S. authorities on cross-border resolution under the “single point of entry” principle, with negotiations for a binding cooperation agreement planned to commence later this year.

Banking Supervision and Deposit Insurance

32. Banking supervision, in particular of domestic banks, need to be further strengthened, including by shoring up resources. The FSAP Update found a high level of compliance with Basel Core Principles and pointed to significant improvements in recent years. However, it also noted that FINMA operates with resources well below those of other supervisors. FINMA could usefully provide more guidance to external auditors (which conduct most onsite banking supervision) as to what is needed, ensure greater harmonization across supervised entities, and complement the auditors’ work with more “deep dives” on selected issues. Auditing firms should furthermore be periodically rotated (at least every five years) and not be paid by the supervised entities, but rather from a FINMA-administered fund. Increased resources for FINMA are needed so it can intensify its supervision of smaller and medium-sized domestically focused banks, particularly in light of risks from large exposures to the domestic mortgage market.

33. The Swiss deposit insurance system needs substantial reform. The FSAP Update indentified a number of weaknesses, and proposed several areas for improvement to bring the system in line with emerging international best practices, including greater transparency to depositors on coverage conditions, commitment to faster payouts, ex ante financing in a dedicated fund, and the fund to have powers to take action other than bank closure when there is a cheaper alternative.

The authorities’ view

34. The authorities believe that supervision is adequately funded and executed, and saw prospects for deposit insurance reform as limited. FINMA stressed that the track record demonstrated that the currently applied risk-based approach to performing supervisory reviews with experienced and skilled staff had been successful. There was nonetheless agreement that domestically oriented banks deserved close attention, and in this context it was pointed out that Pillar II measures had been taken on an individual banks basis, including capital surcharges for institutions with higher interest rate or concentration risks. On deposit insurance, the authorities agreed that aspects of the current system could be improved, but pointed to a recent reform effort that failed to muster sufficient political consensus.

E. Medium-Term Prospects: Immigration, Population Aging, and International Initiatives on Corporate Tax Compliance and Bank Secrecy

35. Despite opposition by the government and many business organizations, a popular vote recently approved the re-establishment of quotas on immigration. The Federal Council now has three years to put in place a quota regime. The free movement of labor was part of a broader set of cooperation agreements reached with the EU in 1999, and contributed to the acceleration in Swiss economic growth in the 2000s (Annex 2). Immigrants account for a large share of the work force in many important sectors. Uncertainty as to the ability to recruit the needed personnel in the future may discourage new investment in these sectors. Additional uncertainty may arise as some other key cooperation agreements with the EU may be called into question. A rapid resolution of this uncertainty would be important to underpin the economic recovery. On the positive side, reduced immigration should take some pressure off the housing market.

36. Slower immigration will increase the challenges of an aging population, and the new legislative pension reform proposal is welcome. To tackle the long term fiscal challenge arising from population aging, the government unveiled the pension reform proposal “Pension 2020.” The objective is to ensure sustainable financing of Pillar I and Pillar II pensions while maintaining current benefit levels. The main measures include: (i) harmonizing the reference retirement age for men and women at 65; (ii) facilitating a flexible transition to retirement from the age of 62 and cutting benefits for early retirement; (iii) introducing a sustainability rule for social security funds, which requires reversible automatic increases in contributions or cuts in benefit indexation in case measures proposed by the Federal Council to the Parliament fail to prevent the funding ratio from falling below 70 percent and deficits exceed 3 percent for two consecutive years. In addition, for Pillar II pensions the reform would reduce the minimum conversion rate from 6.8 percent to 6 percent and redefine the minimum interest rate at the end of each year when the achieved investment performance is known. A two percentage point increase in the VAT and higher social security contributions would finance the cost. Staff stressed that aligning male and female retirement age is appropriate, and placing the social security funds under a fiscal rule, as are most cantonal budgets and the federal budget, should reduce fiscal risks going forward.

37. The tax treatment of corporate income on foreign activities is coming under international scrutiny. Among several factors that make Switzerland attractive to multinational corporations is a favorable corporate income tax regime in many cantons, while bank secrecy has been an important factor for the wealth management sector. Responding to international pressures, the authorities are developing a strategy to reform special tax regimes that give more favorable tax treatment to income from foreign operations than income from domestic operations while maintaining Switzerland’s attractiveness to international firms. The reform is envisaged to enter into force as of 2018.6 Staff welcomed this plans and recommended that, in designing a new regime, the authorities take into account international efforts to counter base erosion and profit shifting in corporate taxation.

38. In parallel, international initiatives to address tax evasion and money laundering are eroding bank secrecy. This presents potential challenges to parts of the Swiss wealth management business and staff stressed the need to closely monitor this sector during the likely process of downsizing to avoid possible risks to financial stability. To protect the integrity of Switzerland as an international financial center, the authorities are also encouraged to forcefully implement the FATF and Global Forum standards in particular with respect to criminalization of tax crimes as predicate offences to money laundering, the transparency of legal persons, and due diligence requirements for politically exposed persons.

The authorities’ view

39. The authorities considered that it was early to assess the possible effects of the referendum on immigration, but were optimistic about succeeding with pension reform. They agreed that uncertainty over the final outcome was not helpful to growth and noted that the Federal Council was moving forward speedily to develop possible strategies. On pension reform they stressed the importance of reforming Pillar I and II together and noted that the parliamentary process was likely to be protracted, with enactment of the reform expected by 2020. On corporate income tax reform, they stressed their goal of maintaining international competitiveness, and informed that buffers were being built in the federal budget for possible burden sharing of the revenue losses with the cantons. On the wealth management sector, the authorities do not expect large adverse effects as competing financial centers will also adopt the new standards. The authorities also informed on progress in implementing international AML-CFT standards. A draft bill for implementing the revised 2012 Financial Action Task Force Recommendations (FATF) was approved by the upper house and should be taken up by the lower house later this year. An FATF Evaluation will start in the fall of 2014 and be finalized in 2016.

Staff Appraisal

40. The exchange rate floor continues to be a necessary element of the monetary policy framework. Inflation is still close to the bottom of the range compatible with the SNB definition of price stability, and, renewed exchange rate appreciation, as might arise from a new bout of safe haven inflows, would quickly bring back deflationary pressures. Thus, monetary conditions need to remain expansionary and the exchange rate floor needs to remain in place. Negative interest rates on banks’ excess reserves may need to be introduced in case of renewed strong pressures on the franc. The SNB balance sheet is likely to remain extended for a prolonged period with large fluctuations in mark-to-market profits, and provisions need to be strengthened to bring capital in line with risks.

41. Stronger policies to curb the demand for mortgages are needed to reduce the risk of a sharp adjustment down the road. The recent hike in the CCB is welcome, but its impact may not be sufficient as capital is not a constraint across the domestically oriented banking sector. More aggressive policies to discourage vulnerable households from taking on too much mortgage debt need to be put in place. To this end, existing self-regulation measures should be tightened, for example to speed up loan amortization. Parallel measures to curb mortgage growth in the buy-to-let segment should also be put in place. However, given the limited effect of self-regulation so far, stricter direct regulation may be necessary, including mandatory affordability caps and maximum loan-to value ratios. This would be an appropriate time to phase out tax incentives that encourage borrowing to finance home buying.

42. A rapid resolution of uncertainty related to future immigration policy would be important to underpin the economic recovery. The recent referendum to move away from the free movement of labor with the EU has increased uncertainty about medium-term economic prospects. Immigration has increased the labor force by about one percentage point per year since the free movement of labor accord with the EU came into force. Immigrants account for a large share of the work force in many important sectors. Uncertainty as to the ability to recruit the needed personnel in the future may discourage new investment in these sectors. Additional uncertainty may arise as some key cooperation agreements with the EU could be called into question.

43. Slower immigration will increase the challenges of an aging population, and the new legislative pension reform proposal will help in meeting these challenges. The proposal aims at placing first and second pillar pensions on a sustainable financial basis in light of population aging. Aligning the retirement age of women with that of men is appropriate, and placing the social security funds under a fiscal rule, as are most cantonal budgets and the federal budget, should reduce fiscal risks going forward.

44. Plans to reform the corporate income tax to make it internationally acceptable are welcome. Specifically, the authorities are seeking to eliminate the favorable tax treatment on income from foreign activities granted to corporations by cantons. This initiative is welcome and the authorities are encouraged to put in place a new regime taking into account international efforts to counter base erosion and profit shifting. The strategy to build buffers in the federal budget for possible burden sharing of the fiscal costs with the cantons should facilitate this reform.

45. Continuing the financial sector reform agenda will strengthen the soundness and resilience of the financial system. The latter is important for global financial stability given the prominent role of the Swiss banking and insurance sectors. In line with the FSAP update recommendations, the authorities are encouraged to:

  • Press the large banks to continue efforts to rapidly bring their leverage ratios into line with those of other major international banks, ensure an ambitious minimum leverage ratio requirement, and improve transparency as regards risk weights.

  • Continue discussions with international counterparts to reach agreement on measures to make the large banks resolvable without public sector support.

  • Increase resources available to FINMA for banking supervision, in particular so it can extend its intensive supervision in the sector beyond the largest banks. Refine FINMA’s use of external auditors for onsite supervision of the banks, including through periodic rotation of auditing firms, ensuring auditors are paid from a FINMA-managed bank-financed fund, and providing more guidance on their supervisory focus.

  • Overhaul the deposit insurance scheme to bring it into line with emerging international best practices and the schemes being established in the region. This involves greater transparency to depositors on coverage conditions, commitment to faster payouts, ex ante financing in a dedicated fund, and the fund to have powers to take action other than bank closure when there is a cheaper alternative.

46. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Key FSAP Recommendations

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Authorities’ Response to Past IMF Policy Recommendations

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Risk Assessment Matrix7

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Table 1.

Switzerland: Selected Economic Indicators, 2010-15

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Sources: Haver Analytics; IMF’s Information Notice System; Swiss National Bank; and IMF Staff estimates.

Contribution to growth.

Reflects new GFSM 2001 methodology, which values debt at market prices.

Based on relative consumer prices.

Table 2.

Switzerland: Balance of Payments, 2008–15

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Sources: Haver Analytics; Swiss National Bank; and IMF staff estimates.

Includes derivatives and structured products.

Table 3.

Switzerland: General Government Finances, 2010–15

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Sources: Federal Ministry of Finance; and IMF staff estimates.

Includes the balance of the Confederation and extrabudgetary funds (Fund for Large Railway Projects, ETH Domain, Infrastructure Fund, Swiss Alcohol Board, Swiss Federal Institute for Vocational Education and Training, Swiss National Museum, Pro Helvetia, Swiss National Science Foundation, Switzerland Tourism).

Includes old age, disability, survivors protection scheme as well unemployment and income loss insurance.

Table 4.

Switzerland: SNB Balance Sheet

(Millions of Swiss francs; unless otherwise indicated)

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Sources: Swiss National Bank; and IMF staff estimates.

Currency in circulation and sight deposits of domestic banks.

Table 5.

Switzerland: Financial Soundness Indicators

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Source: Swiss National Bank.

Based on parent company consolidation. This consolidation basis equals the CBDI approach defined in FSI compilation guide plus foreign bank branches operating in Switzerland, and minus overseas deposit-taking subsidiaries.

Until 2004, general loan-loss provisions were made; as of 2005, specific loan-loss provisions have been carried out.

From 2008 onwards broader criteria pursuant to national accounting regulations (FINMA-RS 08/2 Art. 228b) has been applied for defining non-performing loans.

As percent of total credit to the private sector.

Mining and extraction, production and distribution of electricity, natural gas and water, financial intermediation, social security, ex-territorial bodies and organizations, other.

These ratios were calculated from numbers that originate from the Basle I as well as from the Basle II approach. Therefore, interpretation must be done carefully since they can vary within +/- 10%.

Not yet available.

Table 6.

Switzerland: General Government Operations, 2006–10

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Source: Federal Ministry of Finance.
Table 7.

Switzerland Federal Government Debt Sustainability Analysis (DSA)-Baseline Scenario

(in percent of GDP unless otherwise indicated)

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Source: IMF staff.

Public sector is defined as central government.

Based on available data.

Long-term bond spread over German bonds.

Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

Derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 8.

Switzerland Federal Government DSA - Composition of Public Debt and Alternative Scenarios

(in percent of GDP unless otherwise indicated)

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Source: IMF staff.

Annex 1. Surges in Global Financial Volatility and the Swiss Franc1

1. Switzerland’s attraction as a safe haven was re-affirmed during recent bouts of global financial turbulence. The heightened market volatility following the May 22, 2013 Fed “taper talk” saw the franc strengthen against major EM currencies, the euro, and the U.S. dollar. The latter outcome suggests that volatility-induced safe haven inflows dominated any portfolio re-allocation away from Switzerland which may have occurred due to a higher yield differential vis-à-vis the United States. After a brief respite from positive news about the euro area, safe haven inflows resumed in January 2014 on renewed market concerns about EM resilience. These inflows have been further reinforced by the crisis in Ukraine.


Franc Appreciation Against Major Currencies After May 22, 2013 and Since January 20141

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Source: IMF’s Internatinal Financial Statistics.1 Index = 100 on Jan 4, 2013; for CHF/EUR, actual exchange rate shown on inverted right scale; upward trend shows franc appreciation; BIITSR is average index for currencies of BR, ID, IN, TU, ZA, RU.

10-year Sovereign Yields

(basis points)

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Source: Haver

2. Although small relative to 2009–12 levels, the recent inflows indicate Switzerland’s particular vulnerability to major shifts in global risk sentiment. The franc has appreciated against other safe haven currencies since end-2013. At the same time, Switzerland has received the largest of global mutual fund inflows as a percent of GDP. A materially stronger franc would threaten to push down Swiss inflation, already close to zero and the lowest among peers. The fact that Swiss long-term yields have again sunk below 1 percent, means even less space for (conventional) monetary accommodation to guard against deflation/recession risks.


Global Mutual Fund Inflows Since end-2013

(Cumulative, percent of projected 2014 GDP)

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Source: EPFR Global.

3. Simulations from staff’s G20MOD2 illustrate that absent an exchange rate floor Switzerland could slip into deflation/recession in an adverse global scenario. The simulations consider a scenario of disorderly unwinding of UMP, coupled with geo-political tensions in Europe, resulting in a 100 basis point increase in the sovereign risk premia of stressed euro area economies and EMs over 2014–17. The associated safe haven inflows appreciate the franc by an average of 5 percent against the euro (and in real effective terms) during 2014–15, unwinding by 2018. With the policy rate bound at zero, the simulations show Swiss inflation falling below zero in 2014–15 and output losses peaking at 1.6 percent in 2015 (relative to staff baseline). The Swiss outcomes turn out to be worse than for the euro area and the United States, as those two areas avoid deflation. These results help underscore the pivotal role of the exchange rate floor in the Swiss monetary framework, as a necessary buffer against another major currency appreciation-deflation-recession cycle.

G20MOD Simulations Results for Scenario with EM/EA Stress and Safe Haven Inflows into Switzerland Under a Fully Flexible Exchange Rate

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Source: Staff estimates based on the G20MOD of the IMF Research Department.

Annex 2. A New Approach to Immigration?1

1. A recent popular initiative, approved by a narrow majority through a referendum, calls for new restrictions on immigration. The vote reflected public concerns about the pressure placed by high rates of immigration on transport, infrastructure, the housing market, education services, and local employment.

2. Switzerland has experienced a new immigration wave since the enactment of the Free Movement of Persons Treaty (FMP) with the EU/EFTA in June 2002 gradually led to the full liberalization of immigration from these countries. During 2002–12, total population growth was 0.94 percent per year and net immigration contributed 0.88 percentage points to the total. The share of foreign born inhabitants in total population increased from 20 percent in 2001 to 25 percent in 2012, one of the highest among OECD countries. The share of foreign born in the labor force was 29 percent in 2012. In 2002–12, EU citizens accounted for 60 percent of net immigration, while there was virtually no net immigration from the EU in the previous decade, with Germany the most represented country. About a third of the foreign-born population is highly educated, a higher proportion than the native population.

3. The recent popular vote creates uncertainty to medium-term economic prospects. Highly skilled immigrant workers are important for sectors such as finance, pharmaceuticals, and health care, while lower-skilled ones play an important role in construction. Immigration restrictions may hamper recruitment, which may in turn affect investment and location decisions by firms. In addition, slower immigration would cause old-age dependency to rise, with adverse effects on the social security funds. Lower long-term growth would also lead to less favorable public debt dynamics. A recent OECD study assesses the fiscal benefits of immigration in Switzerland at about 2 percent of GDP, among the highest in the OECD countries.

4. Finally, the FMP is part of a bundle of seven bilateral agreements with the EU covering free movement of goods and services as well as agriculture and public procurement. These treaties may be called into questions by the EU and may need to be renegotiated, creating uncertainty for a numbers of economic activities.


Real GDP Growth and Population Growth

(Percent change)

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: Eurostat, and Haver Analytics.

Real GDP Growth and Labor Force Growth

(Percent change)

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Source: Haver Analytics.

Percent of Highly Educated Population

Citation: IMF Staff Country Reports 2014, 142; 10.5089/9781498312967.002.A001

Sources: US Current Population Survey; other non-European countries, Finland and the United Kingdom: Database on Immigrants in OECD Countries (DIOC) 2005–06; other European countries: European Union Labour Force Survey (Eurostat).


See Risk Assessment Matrix below for details.


Under a fully implemented Basel III capital definition, breach of the CET1 ratio of 7 percent threshold would trigger the conversion of contingent capital and recovery measures according to the Swiss framework.


See also Selected Issues Paper for the 2013 Article IV Consultation: “Outward Spillovers from Swiss G-SIBs in Times of Financial Stress.”


For more details, see 2013 Selected Issues Paper, “SNB’s Balance Sheet Risks and Policy Implications.”


There is cross-country evidence that DTI limits can be effective in curbing real estate and mortgage booms (e.g.; Lim, Columba, Costa, Kongsamut, Otani, Saiyid, Wezel, and Wu, 2011, “Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences,” IMF Working Paper No. 11–238; Igan and Kang, 2011. “Do Loan-to-Value and Debt-to-Income Limits Work? Evidence from Korea”, IMF Working Paper No. 11–497; Kuttner, and Shim, 2013, “Can Non-Interest Rate Policies Stabilize Housing Markets? Evidence from a panel of 57 economies,” BIS Working Papers No 433).


The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.


Prepared by S. Ali Abbas and Yingbin Xiao (EUR), Keiko Honjo and Dirk Muir (RES).


G20MOD is a module of the IMF’s Flexible System of Global Models (FSGM).


Prepared by Yingbin Xiao and S. Ali Abbas.