Abstract
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.
General
On behalf of the Swiss authorities, we would like to thank staff for their reports, which provide a thorough analysis of macroeconomic developments and the financial sector. In many aspects, we share staff’s views on the challenges going forward. We would like to extend our appreciation to staff for their policy recommendations, which add significant value to policy discussions in Switzerland. While many of these recommendations are in line with policies that are already being implemented in Switzerland, others, in particular those linked to the FSSA, deviate to a varying extent from the views of our authorities.
Outlook
The Fund’s outlook for the Swiss economy is broadly in line with our authorities’ forecasts. The Swiss economy continued to grow robustly in 2013. This growth was mainly driven by domestic sectors such as construction, investment and household consumption. High immigration and low interest rates were the key factors for the strong domestic demand. The export sector, which previously suffered from a weak external environment, is showing signs of recovery. Our slightly higher forecast for growth in 2015 is close to staff’s and reflects the considerable uncertainties around future external developments. We also share staff’s assessment of the risks faced by the Swiss economy, especially those associated with the imbalances in the housing and mortgage markets.
Monetary and exchange rate policy
The SNB fully shares staff’s view that monetary conditions need to remain expansionary and that the exchange rate floor needs to remain in place. Even though the SNB has not had to buy foreign currency to enforce the floor for more than a year, the floor remains necessary to avoid an undesirable tightening of monetary conditions. The Swiss franc continues to be overvalued, the policy rate (3M-Libor) is at the zero lower bound, and inflation – having been negative for two years – is just returning to zero. Renewed exchange rate appreciation due to safe haven inflows would quickly bring back deflationary pressures. The SNB also concurs with staff that in such a scenario, negative interest rates on bank excess reserves would be an option.
As the SNB has stressed several times, if necessary, it is prepared to buy foreign currency in unlimited quantities in order to enforce the minimum exchange rate. This takes precedence over any other considerations regarding the accumulation and investment of its foreign exchange reserves. The SNB currently has no plans to unwind or limit its foreign exchange reserve accumulation. While staff refers to the risks arising from the large balance sheet of the SNB, the SNB has stepped up provisioning to strengthen its balance sheet, as also noted by staff.
Fiscal policy
Overall, fiscal policy remains on solid ground in Switzerland. The general government is expected to record a small budget surplus in 2013 (0.3 percent of GDP), as the small deficit of the Confederation and the sub-central entities is compensated for by a surplus in the social security funds. In 2014, the general government balance is expected to turn slightly negative (-0.2 percent of GDP), mainly due to a lack of profit distributions from the SNB and further one-off restructuring contributions towards cantonal pension funds. However, fiscal indicators are expected to improve considerably in the years thereafter, with general government recording solid surpluses. Accordingly, the general government debt should fall further to 44 percent of GDP in 2017.
Financial sector policies
We welcome staff’s positive assessment of financial system stability and the observance of standards and codes in Switzerland. We appreciate staff’s recognition of Switzerland’s considerable progress in implementing the 2007 FSAP recommendations, the timely adoption of the Basel III framework, the swift introduction of measures addressing the too-big-to-fail problem, stricter liquidity requirements, a countercyclical capital buffer and focused measures addressing a potential overheating in the Swiss residential real estate market. We also take good note of the high overall compliance with the Basel Core Principles (BCPs) and Insurance Core Principles (ICPs). The positive results of the stress testing exercises confirm the resilience of the Swiss financial sector. Moreover, we appreciate that staff acknowledge the progress Switzerland has made in addressing the recommendations from the last IOSCO assessment and support the current reforms in the area of securities regulation. This being said, we would like to comment in greater detail on some important aspects of the key FSAP recommendations.
FINMA’s supervisory effectiveness and resources
We welcome staff’s recognition of the strength of the Swiss supervisory approach including the institutional setup of the Swiss Financial Market Supervisory Authority (FINMA) as an integrated supervisory authority. We also appreciate staff’s conclusion that employing external resources from audit firms is a reasonable and valid supervisory approach, in particular given the global operations of large Swiss banks and the limited availability of highly-specialized supervision experts in Switzerland. It is further acknowledged by staff that FINMA has successfully put in place important enhancements to its own supervisory processes and practices, especially with regard to big banks. Finally, we value staff’s assessment regarding the appropriateness, also in terms of resources, of Swiss G-SIB home-supervision.
Effective supervision carried out by FINMA has contributed to the increased robustness and resilience of the Swiss financial sector, as recognized by staff. We are not of the opinion that there are “significant weaknesses in supervision”. We would like to remind that since 2008 no important Swiss bank has had difficulties, multiple institutions have left the market without affecting creditors or clients, and the Swiss deposit insurance has not dispensed funds over this period. We do not believe that staff’s recommendation to improve the process towards mandating external audit firms is a sufficient justification to conclude that there are significant weaknesses in supervison, in particular given the assessors’ general acknowledgement of this supervisory approach. We also would like to stress that the wording “significant weaknesses” is not consistent with staff’s careful and more constructive assessment in the Report on the Observance of Standards and Codes on the same issue.
Our authorities think that FINMA resources are appropriate to fulfill its mandate. They remain of the opinion that staff’s assessment grade for the relevant BCP is not justified, especially as staff came to the conclusion that this issue is only valid for a very limited area -the supervision of small and medium sized banks. With BCP 2 primarily geared towards the process of obtaining and allocating resources in order to avoid political pressure which could undermine supervisory independence, our authorities’ views is that FINMA’s budgetary independence is clearly anchored in the law, as acknowledged in the FSSA. FINMA’s current level of resources can thus be adjusted flexibly. Furthermore, the narrow focus on FINMA’s internal resources available for bank supervision completely omits the important contribution of external audit firms to successful supervision. Accounting for these firms, Switzerland’s resources allocated to bank supervision are well within the range of comparable jurisdictions.
Capital requirements and leverage ratio on banks
Switzerland has introduced a leverage ratio for large banks in addition to risk-weighted capital requirements well ahead of the envisaged Basel standard and a comprehensive “too-big-to-fail” (TBTF) regime which is explicitly based on parallel requirements, including capital, leverage, liquidity and resolution measures. Our authorities therefore disagree with staff’s statement that “early focus on regulatory bank capital has not been matched by equal focus on other measures of bank strength, particularly the leverage ratio”. However, we agree with staff’s view that the two large Swiss banks need to further improve their leverage ratios.
Mortgage and housing markets
Our authorities are well aware of the risks associated with developments in the mortgage and housing markets. In order to address these risks, measures have already been taken in 2012 and 2013. These measures include (i) the activation of the countercyclical capital buffer with a focus on residential property mortgages, (ii) prudential measures taken by FINMA, (iii) a revision of self-regulation guidelines for mortgage lending, and (iv) the Federal Council’s decision to increase the countercyclical capital buffer requirements, effective in June 2014. Our authorities will continue to monitor developments in the mortgage and housing markets closely, and will reassess the need for an adjustment to the CCB on a regular basis. Moreover, given the potential overheating of the Swiss mortgage market, discussions are currently taking place about the design and implementation of further measures directly targeting the banks’ risk-taking.
Resolution regime and use of deposit insurance funds
The current Swiss TBTF-regime does not include an ex-ante funded resolution scheme. This reflects a deliberate policy decision to avoid wrong incentives and moral hazard. Instead, Swiss banks are required to issue a minimum amount of contingent convertible debt which is the functional equivalent of an internalized, institution-specific resolution fund. Our authorities are not convinced by staff’s key recommendation to make deposit insurance funds available to finance resolution measures.
Swiss Solvency Test for insurers
Our authorities appreciate the support expressed by staff for various areas of improvement in the regulation and supervision of insurers, including with regard to group supervision and the Swiss Solvency Test (SST). The latter was introduced in 2010 and is a fully risk-based, market consistent solvency regime for insurers, considerably ahead of other comparable international instruments. Since staff raised certain concerns regarding the SST adjustments permitted in 2013 to accommodate the persistent low interest environment and the late introduction of the Solvency II framework in the European Union, it is important to note that these measures are transparent, temporary (they are due to expire at the end of 2015), carefully designed and targeted to avoid wrong incentives, and apply only to existing business. Further, they are intended for and have been used primarily by life insurers who have been hit the most from the low interest rate environment and an uneven international playing field.
Financial Markets Infrastructure regulation
Full implementation of the CPSS-IOSCO Principles for Financial Market Infrastructures (PFMIs) by the systemically important financial market infrastructures in Switzerland is a top priority for our authorities. Substantial progress has been achieved and financial market infrastructures are expected to be compliant with most requirements by Summer 2014. The staff highlights some of the challenges in implementing the PFMIs, including an environment focused on efficiency and subject to competition. It should be noted that the situation in Switzerland is similar to many other countries with regard to these challenges.