Selected Issues

Abstract

Selected Issues

Switzerland’S International Reserves1

A. Reserve Accumulation

1. Monetary policy actions since the onset of the GFC have significantly expanded the SNB’s balance sheet and international reserves. Prior to the crisis, the SNB’s balance sheet was small and similar in size to that of other major central banks. Since then, foreign exchange purchases by the SNB and returns on these assets have grown its balance sheet, which now stands at around 120 percent of GDP, one of the largest in the world relative to GDP. Unlike some other major central banks, the increase was due to purchases of foreign—rather than domestic—assets. Interest income and dividends received on these foreign assets will continue to passively raise international reserves, while changes in foreign prices of these assets and in the value of the franc will also affect the stock of reserves.

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Total Assets of Major Central Banks

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Source: Haver.
uA02fig02

Foreign Exchange Reserves Excluding Gold, 2018

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Source: IMF IFS.

2. The SNB’s focus on foreign assets reflects the relatively small stock of Swiss franc assets and the large role of the exchange rate in inflation developments. Early in the global financial crisis (GFC), the SNB expanded the money supply by raising its holdings of a range of assets, including Swiss franc securities (mainly bonds issued by the domestic private sector).2 However, given the relatively small size of franc-denominated asset markets, that domestic credit growth remained robust and the risk of severe deflationary pressure given the franc’s status as a safe haven, the SNB increasingly focused on unsterilized foreign exchange purchases to expand its balance sheet and effectively support inflation and growth once the policy interest rate had been reduced close to zero. To further counter deflationary pressure, in September 2011, the SNB introduced an exchange rate floor against the euro, thereby committing to purchase foreign exchange to prevent the franc from strengthening. Removal of the floor in early 2015, even though it was accompanied by the introduction of a negative policy interest rate, saw additional large inflows and led to further accumulation of reserves.

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Source: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions

3. The SNB’s FX purchases were concentrated into relatively few episodes. Intervention, as proxied by the sum of changes in sight deposits at the SNB and currency in circulation, was especially large in August 2011, and purchases were also sizable around April 2010, June 2012 and January 2015.3 Around 85 percent of cumulative foreign exchange purchases occurred during inflow surge episodes (defined as monthly purchases that exceeded the mean by 1 standard deviation or more).4 Unlike some other central banks, intervention occurred mainly in the spot market.

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SNB Currency and Deposits Accumulation During Surges

(CHF billions and percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations

B. Some Additional Motives for Holding Reserves

4. While the SNB’s stock of reserves is a by-product of its constrained monetary policy, there are a number of reasons why it—together with other central banks—may wish to hold reserves. The literature shows that during financial crises, including the GFC, central banks provide substantial emergency liquidity assistance in domestic and foreign currencies (Domanski and others (2014), CGFS (2010), Ghosh and others (2017)). In fact, some advanced and emerging countries pursuing inflation targeting have acquired significant reserves since the GFC, including Sweden, Israel, the Czech Republic and Poland. The two Swiss G-SIBs—which are very large relative to the size of the domestic economy—as well as several domestically-focused banks are active in international financial markets. These financial institutions’ own liquid foreign-currency assets should provide the first line of defense during liquidity stress. However, during extreme episodes of market disruption, temporary provision of foreign exchange liquidity by the central bank may be warranted to protect financial stability.

5. Prior to the GFC, the prospect of losing exchange market access and of external-sector crises was perceived to be remote for a reserve-currency country such as Switzerland. However, the onset of the crisis caused the market for US dollars to freeze as risk-averse investors hoarded what was perceived to be the global safe asset, while concerns about counterparty risk caused repo markets to seize. As with other major international banks, the two Swiss G-SIBs were affected by foreign exchange liquidity shortages. Moreover, the declining share of the Swiss franc in global foreign exchange market turnover—which has accelerated since the GFC—may indicate a less-liquid market for the Swiss franc, which could intensify during stress periods, creating the need for precautionary balances.5 On the other hand, as occurred during the GFC, the SNB may be able to participate in currency swap arrangements in the event of severe international financial market stress, thereby reducing the need to hold foreign exchange reserves.6

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Distribution of OTC Foreign Exchange Bilateral Currency-Pair Turnover, 2016 /1

(Percentage shares)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Source: BIS Triennial Central Bank Survey of foreign exchange and OTC derivatives./1 As two currencies are involved in each transaction the sum of shares in individual currencies will total 200 percent.

C. Reserve Management and Asset Allocation

6. The SNB’s management of its reserves is governed by investment policy guidelines.7 Monetary policy takes primacy over foreign exchange reserve management in order to avoid conflicting objectives. Reserve management is guided by security, liquidity and return on investment. As one of the world’s major investors, the SNB seeks to avoid disrupting the markets in which it participates,8 thereby creating a preference for deep markets and adjusting gradually to its desired portfolio. It also implies that the currencies purchased in the context of intervention need not be the same as the ultimate basket of currencies in its reserve’s portfolio. The SNB’s Governing Board sets the broad investment principles and strategy, while the SNB’s Asset Management unit implements the strategy, and its Risk Management unit monitors implementation.9

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SNB’s Foreign Assets

(Percent of total)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations.

7. The SNB’s reserve portfolio comprises of gold and highly-rated sovereign bonds, as well as other assets that are less-commonly held by central banks:

  • Gold represents around five percent of the SNB’s foreign assets.

  • Of foreign currency assets, nearly 70 percent are held in government bonds (including deposits at central banks and the BIS), 12 percent are in corporate and other bonds, while equities account for one-fifth.10

  • By currency, nearly 40 percent is in euros, 35 percent is in US dollars, with eight percent in Japanese yen and 15 percent in other currencies.

  • Of fixed-income assets, just-below 60 percent are rated AAA, over 20 percent are rated AA, with most others A-rated.

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SNB Foreign Currency Investments

(Percent of total)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; IMF staff calculations
uA02fig07

SNB Foreign Currency Investments

(Percent of total )

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations

8. Unlike for most other central banks, equities form a sizable share of the SNB’s foreign exchange reserves, supporting diversification and higher returns. The equity portfolio consists of shares of mid- and large-capitalization companies in advanced economies and, to a lesser extent, shares of small-capitalization companies, as well as shares of companies in emerging economies. The SNB invests passively, based on a combination of standard equity indices spanning different markets and currencies. While this passive investment strategy ensures that holdings in individual companies remain as low as possible, it nonetheless implies that the SNB owns—in absolute terms— substantial equity positions in US companies with high market capitalization, including major US technology sector companies.11 However, to avoid potential conflict of interest in the event the SNB has an informational advantage over other investors, the SNB does not invest in shares of mid- or large-capitalization banks. The SNB also does not own equities in companies that are “gross violators of ethical principles” (i.e., produce internationally-banned weapons, seriously violate fundamental human rights or systematically cause severe environmental damage). Consistent with being a passive investor, the SNB exercises its voting rights selectively, and instances are limited to ensuring good corporate governance.12

D. Reserve Coverage, Gross International Liabilities, and SNB Capital, Income and Distribution

9. Standard indicators suggest the SNB has adequate foreign reserves, notwithstanding a large financial sector. At around 120 percent of GDP, reserves cover around 22 months of imports. Reserves also cover around 120 percent of banks’ short-term foreign liabilities and around three-quarters of economy-wide short-term foreign liabilities.13 Relative to gross foreign liabilities by individual currency, reserves cover a substantial portion, but with considerable variation across currencies.14

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Reserve Coverage of Short-Term External Liabilities

(Percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations.
uA02fig09

Reserve Coverage by Currency of Gross External Liabilities

(Percent)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations.

10. Reserves appear more-than-adequate from the perspective of foreign exchange mismatches.15 Banks are required to comply with liquidity coverage ratios on their foreign currency exposures. Moreover, for the private sector as a whole, foreign assets are denominated in foreign currencies, while foreign liabilities are mostly denominated in Swiss franc. This net long foreign currency position of the private sector is augmented by the long foreign currency position of the SNB. Nonetheless, despite that in the aggregate the private sector is net long in foreign currency, the sector—or segments thereof—may still have foreign currency liquidity mismatches.16

uA02fig10

Foreign Currency Assets and Liabilites

(Percent of GDP – assets=positive, liabilities=negative)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations.
uA02fig11

Foreign Currency Assets and Liabilites, Excluding Reserves

(Percent of GDP – assets=positive, liabilities=negative)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB; and IMF staff calculations.

11. The SNB has tended to earn a positive return on its reserves. Exchange rate fluctuations and changes in asset valuations17 generate mark-to-market gains and losses for the SNB. 18 Moreover, because the NEER tends to increase over time, large FX reserves—whose fluctuations against the franc are unhedged (given that hedging is in effect a purchase of Swiss franc against other currencies, and could conflict with monetary policy goals)—tend to generate sizable valuation losses.19 Nonetheless, total returns (measured in Swiss franc terms) on reserves have averaged 2.6 percent since 2006, despite negative outcomes in five of those years. This reflects the generally-positive local-currency-denominated returns which have tended to offset losses from appreciation of the franc. Cumulative profits since 2006—mainly attributable to reserves—reached around one-sixth of 2018 GDP by early 2019.

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SNB Profits and Losses

(CHF billions)

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Sources: SNB Annual and interim reports.

12. Profits are used to build capital and fund distributions to the general government. Part of profits is used to raise provisions by a minimum of 8 percent per year, and a small amount is paid as dividends to shareholders. Current profit is also shared with the Confederation and cantonal governments in the amount of CHF 1 billion per year, with any remaining unallocated profit accumulated in a distribution reserve to support an additional annual CHF 1 billion disbursement to the Confederation and cantonal governments whenever the balance in that reserve exceeds CHF 20 billion. The SNB’s provisions currently stand at CHF 73 billion (11 percent of GDP) and the balance in the distribution reserve is CHF 43 billion.

uA02fig13

SNB Reserves—Return on Investments

((In percent))

Citation: IMF Staff Country Reports 2019, 181; 10.5089/9781498321501.002.A002

Source: SNB.

13. The SNB’s large balance sheet and profits have at times attracted proposals on how these could be allocated or spent. Proposals to create a sovereign wealth fund, to more than double the share of gold in reserves, to invest in Switzerland, and to change the functioning of the SNB have been rejected so far.20 Had they been approved, these proposals would have restricted the flexibility of the SNB to make monetary policy and reserve-accumulation decisions.

References

  • Committee on the Global Financial System Markets Committee (2010). The functioning and resilience of cross-border funding markets. CGFS Paper, 37.

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  • Domanski, D., Moessner, R., & Nelson, W. R. (2014). Central banks as lenders of last resort: experiences during the 2007–10 crisis and lessons for the future. BIS Paper, (79c).

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  • Ghosh, A. R., Ostry, J. D., & Tsangarides, C. G. (2017). Shifting motives: Explaining the buildup in official reserves in emerging markets since the 1980s. IMF Economic Review, 65 (2), 308364.

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  • International Monetary Fund, Guidance Note on the Assessment of Reserve Adequacy and Related Considerations, (2016) (Washington: International Monetary Fund).

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1

Prepared by Apostolos Apostolou (EUR). The paper benefited from comments from colleagues at the Swiss National Bank.

3

The proxy for intervention (sum of changes in sight deposits at the SNB and currency in circulation) excludes passive inflows due to income on reserves and valuation changes, both of which affect the level of international reserves (measured in Swiss francs) on the asset side of the SNB’s balance sheet. This measure also does not take into account other changes in the composition of SNB liabilities, which contributed to the surge in sight deposits in August 2011.

4

As the SNB conducted FX swaps during 2008–12, the cumulative share of purchases (including the first leg of FX swaps) occurring during surge episodes exceeded 100 percent for some time.

5

Advanced economies that do not issue a reserve currency or have no automatic access to reserve currencies through standing swap lines may need precautionary reserve buffers in the event of foreign exchange or external funding pressures (IMF, 2016).

6

Standing currency swap lines exist between the Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Bank of Japan and the Swiss National Bank.

8

Speech by SNB Governing Board member Zurbrügg (2012) “Challenges Posed by the Growth in the SNB’s Foreign Exchange Reserves.” (https://www.snb.ch/en/mmr/speeches/id/ref_20121108_zur).

9

Reports are provided regularly to the SNB’s Governing Board and Council.

10

As of Q1:2019. Information is published quarterly. The SNB occasionally invests in derivatives such as futures or interest rate swaps (Zurbrügg, 2012).

11

The SNB provides disclosures of its US equity holdings with the Securities and Exchange Commission. See https://www.sec.gov/Archives/edgar/data/1582202/0001582202–16-000005-index.htm.

12

Speech by SNB Governing Board member Maechler (2016), “Investment Policy in Times of High Foreign Exchange Reserves.”

13

This excludes liabilities associated with Swiss banks’ wealth management units (which are largely off-balance sheet).

14

While individual foreign-currency coverage may not matter when foreign exchange markets are operating smoothly, the market for some currencies could seize up during a rush for global safe assets or concerns about counterparty risk.

15

IMF (2016), “Guidance Note on the Assessment of Reserve Adequacy and Related Considerations” suggests reserve adequacy should be take into consideration reserve drains that can arise from on-and-off balance sheet activities.

16

For example, even though the private sector is long in foreign currency, its short-term foreign currency liabilities could exceed its liquid foreign currency assets.

17

Speech by President of the SNB Council Jean Studer (2018) “Spotlight on SNB profits and shares” discusses how the SNB’s profits arise and how they are used.

18

See SNB ‘Questions and answers on equity capital and profit appropriation’ https://www.snb.ch/en/ifor/public/qas/id/qas_eigenkapital#t14.

19

For example, a 5 percent depreciation of the NEER would lower the value of reserves by around 6 percent GDP.

20

More recently, an initiative has been proposed that would prohibit the SNB from investing in companies making weapons.

Switzerland: Selected Issues
Author: International Monetary Fund. European Dept.
  • View in gallery

    Total Assets of Major Central Banks

    (Percent of GDP)

  • View in gallery

    Foreign Exchange Reserves Excluding Gold, 2018

    (Percent of GDP)

  • View in gallery

    SNB Currency and Deposits Accumulation During Surges

    (CHF billions and percent)

  • View in gallery

    Distribution of OTC Foreign Exchange Bilateral Currency-Pair Turnover, 2016 /1

    (Percentage shares)

  • View in gallery

    SNB’s Foreign Assets

    (Percent of total)

  • View in gallery

    SNB Foreign Currency Investments

    (Percent of total)

  • View in gallery

    SNB Foreign Currency Investments

    (Percent of total )

  • View in gallery

    Reserve Coverage of Short-Term External Liabilities

    (Percent)

  • View in gallery

    Reserve Coverage by Currency of Gross External Liabilities

    (Percent)

  • View in gallery

    Foreign Currency Assets and Liabilites

    (Percent of GDP – assets=positive, liabilities=negative)

  • View in gallery

    Foreign Currency Assets and Liabilites, Excluding Reserves

    (Percent of GDP – assets=positive, liabilities=negative)

  • View in gallery

    SNB Profits and Losses

    (CHF billions)

  • View in gallery

    SNB Reserves—Return on Investments

    ((In percent))