Abstract

Under a floating exchange rate system, the monetary authorities are faced with the dilemma of whether to target the growth in the money supply or the exchange rate. The dilemma is even more acute for an international financial center, where domestic residents have easy access to foreign currency deposits, which might render the demand for domestic money volatile. In addition, the demand for a reserve currency—such as the Swiss franc—reflects the portfolio choices of foreign asset holders and, therefore, might fluctuate with major shifts in world savings, for example, increases in OPEC funds in the first years following the second oil price rise and, more recently, large net savings in Japan. The demand for a reserve currency is also subject to erratic changes as a result of political events. In this respect, the Swiss franc is possibly more sensitive than other reserve currencies owing to the neutrality and bank secrecy of the country. It can also be argued that the small size of the Swiss economy and the money supply make the Swiss franc exchange rate more sensitive to capital flows than the exchange rate of major currencies, such as the deutsche mark.

Relaxation of Capital Restrictions

Under a floating exchange rate system, the monetary authorities are faced with the dilemma of whether to target the growth in the money supply or the exchange rate. The dilemma is even more acute for an international financial center, where domestic residents have easy access to foreign currency deposits, which might render the demand for domestic money volatile. In addition, the demand for a reserve currency—such as the Swiss franc—reflects the portfolio choices of foreign asset holders and, therefore, might fluctuate with major shifts in world savings, for example, increases in OPEC funds in the first years following the second oil price rise and, more recently, large net savings in Japan. The demand for a reserve currency is also subject to erratic changes as a result of political events. In this respect, the Swiss franc is possibly more sensitive than other reserve currencies owing to the neutrality and bank secrecy of the country. It can also be argued that the small size of the Swiss economy and the money supply make the Swiss franc exchange rate more sensitive to capital flows than the exchange rate of major currencies, such as the deutsche mark.

During the fixed exchange rate system, capital controls were used to dampen capital inflows and the resulting increase in domestic liquidity and, thereby, in part, insulate monetary developments in Switzerland from developments abroad. With the advent of floating exchange rates, the Swiss National Bank shifted its policy target to the money supply. The setting of monetary targets began in 1975, the same year as in the Federal Republic of Germany. The shift from fixed to floating exchange rates did not resolve the conflict between exchange rate and monetary policies, as the Swiss franc appreciated strongly in real effective terms until 1978, deteriorating Swiss external competitiveness (Chart 7).33 Therefore, during the first years of floating the Swiss National Bank continued to rely on capital restrictions to limit foreign capital inflows. But these restrictions were not effective in preventing strong capital inflows in 1978 from forcing the authorities to abandon the monetary target for that year. Consequently, from 1979, the Bank began to gradually dismantle nearly all capital restrictions and embarked on a controlled internationalization of the Swiss franc. Since 1980, the authorities have reintroduced monetary targeting as the main policy instrument to secure price stability.

Chart 7.
Chart 7.

Exchange Rate Developments

Source: International Monetary Fund, International Financial Statistics.1An increase (decrease) in the index indicates an appreciation (depreciation) of the Swiss franc; MERM (multilateral exchange rate model).2Relative unit labor cost.

The rest of this section gives a description of the background of capital restrictions and an evaluation of the effects of the removal of capital restrictions on monetary and exchange rate developments and the official reserve role of the Swiss franc. The conclusion reached is that capital controls were largely ineffective during the 1970s and their removal has not given rise to problems in monetary or exchange rate management. This outturn, however, was a crucial result of the sharp tightening in monetary policy abroad during the same period as capital restrictions were removed. Finally, the more liberal access to holdings in Swiss francs has not significantly increased the official reserve role of the Swiss franc.

Recent History of Capital Restrictions

During the 1970s, the Swiss franc was frequently exposed to strong upward pressure. In addition to reducing official interest rates and intervening in the foreign exchange market, the Swiss authorities tried to limit capital inflows through capital controls, while promoting capital exports through a liberal authorization practice. The choice of instruments, however, was greatly impaired by an almost complete lack of information on capital flows.34

In August 1971, when the Swiss franc came under strong upward pressure during the U.S. dollar crisis,35 the Swiss National Bank ceased its intervention in the exchange market and imposed, inter alia, a 100 percent minimum reserve requirement on any increase after July 31, 1971 in banks’ net liabilities to nonresidents and prohibited interest payments on any increase in Swiss franc deposits of nonresidents after July 31, 1971. When the pound sterling began floating in June 1972 and the Swiss franc again came under upward pressure, a new series of control measures was introduced. Nonresidents were not allowed to buy Swiss franc-denominated bonds or other securities or purchase real estate in Switzerland. Furthermore, foreign borrowing by Swiss nonbanks was made subject to authorization. At the same time, a penalty in the form of a commission charge of 2 percent a quarter was levied on all net increases in Swiss franc deposits of nonresidents. This so-called “negative interest rate” was temporarily suspended in October 1973.

After the floating of the Swiss franc in January 1973, the control measures were initially retained. In November 1974, when funds from oil exporters were shifted to Switzerland, the ban on interest payments and a negative interest rate of 3 percent a quarter was reintroduced. In the period from mid-1975 to mid-1977, when exchange rate pressure subsided, capital restrictions were temporarily relaxed; however, in the second half of 1977, upward pressure on the Swiss franc intensified. Consequently, in February 1978, imports of foreign bank notes were restricted, the negative interest rate on increments in nonresidents’ deposits was raised to 10 percent a quarter, and the ban on interest payments was extended to deposits of foreign monetary authorities, which had hitherto been exempted. Finally, as the Swiss franc had appreciated by 26 ½ percent in real effective terms between the second quarter of 1977 and the third quarter of 1978 (Chart 7) the Swiss National Bank abandoned its monetary target in October 1978. Instead, the Bank announced a temporary exchange rate target against the deutsche mark, declaring its intention to intervene in the exchange markets to achieve a rate well above SwF 0.80 per deutsche mark.

The difficulty in preventing capital inflows and the appreciation of the Swiss franc gave rise to a reassessment of policies from 1979. The Swiss National Bank recognized that the main determinants of capital movements were monetary and other economic policies pursued in Switzerland and abroad. Adjustments in asset portfolios to reflect changes in economic conditions could not for a prolonged period be prevented by capital restrictions, because there was ample scope for circumvention.

As a consequence, since 1979 the Swiss National Bank has lifted practically all restrictions on capital inflows. This change was facilitated by the depreciation of the Swiss franc, stemming, in part, from a tightening of monetary policy abroad, especially in the Federal Republic of Germany and the United States. The steps in liberalization are described in detail in Appendix II. In summary, the most significant changes were permission, in January 1979, for nonresidents to buy securities denominated in Swiss francs; elimination of the limit on forward sales of Swiss francs in March 1980; gradual removal in the period to August 1980 of the ban on payment of interest and the levy of negative interest rates on increases in Swiss franc deposits of nonresidents; and removal of a license requirement for borrowing abroad by Swiss residents. The only restriction that remained on capital inflows was the requirement of approval by the cantons for real estate investment by nonresidents in Switzerland. This restriction, however, was not motivated by exchange rate considerations.

Impact of Relaxation of Capital Restrictions

The impact of the removal of capital restrictions since 1979 is discussed here in terms of (1) the monetary target, (2) the exchange rate and interest rate volatility, and (3) the official reserve role of the Swiss franc.

During the first three years of monetary targeting the annual targets were, by and large, observed (Table 6). In 1978, however, Ml expanded by 16 percent against a target of 5 percent. As mentioned earlier, the upward pressure on the Swiss franc subsided in 1979 and a monetary target was again set for 1980. In both 1980 and 1981, however, actual monetary growth fell substantially short of the targets, and the monetary base declined by 7 percent and 0.5 percent, respectively, against an announced target rate of 4 percent for each year. This was partly a result of the reversal of capital flows, but it also reflected a deliberate policy change during the target period to tighten monetary policy in the wake of the inflationary impact of the second round of oil price increases and the sharp tightening in monetary policies abroad. Since 1982, however, the targets have almost been realized, with only limited fluctuations in monetary aggregates.

Table 6.

Monetary Targets in Switzerland

(Percentage change)

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Sources: Swiss National Bank, Annual Reports and Monatsbericht.

The target for 1980 refers to the increase in the monetary base from mid-November 1979 to mid-November 1980. For the other years the target refers to annual average growth rates (average of monthly growth rates).

From the beginning of 1979 to the end of 1985, the Swiss franc has depreciated by 22 percent against the U.S. dollar but appreciated by 5 percent against the deutsche mark. While the Swiss franc depreciated almost continuously against the U.S. dollar until the first quarter of 1985, it fluctuated against the deutsche mark (between SwF 78 and SwF 91 per deutsche mark during the same period).36 In real effective terms (relative unit labor costs), the Swiss franc has depreciated by 15 percent from 1978 to the first half of 1985, thereby partly reversing the appreciation that took place in the earlier part of the 1970s.

Monetary and exchange rate developments since 1979 have clearly been influenced by the tightening in monetary conditions in the United States and the sharp appreciation of the U.S. dollar. As these developments have coincided with the removal of capital restrictions, it is difficult to distinguish between the effects of the separate events. However, movements in the spread between domestic interest rates and Euro-interest rates for a currency may be looked to as evidence of effective capital restrictions.37 Changes in the spread between the two rates might indicate changes in transaction costs associated with capital restrictions or other impediments to interest rate parity. As Chart 8 shows, with the exception of 1974, there is no indication of significant changes in the difference between domestic and Euro-Swiss franc interest rates. The two rates follow each other closely, pointing to the existence of free capital movements both before and after the removal of capital controls. Statistical testing of the two subperiods in terms of the means and standard deviations of the differences in interest rates also confirms that the difference has not diminished since the elimination of restrictions. This would seem to confirm the view that capital restrictions in place before 1979 were ineffective. A similar experience of unsuccessful application of capital controls was made in the Federal Republic of Germany, which also experienced massive capital inflows during the 1970s despite extensive administrative measures to prevent them.38

Chart 8.
Chart 8.

Three-Month Domestic and Euro-Swiss Franc Deposit Rates

Source: Swiss National Bank, Monatsbericht.1Three-month deposit rates in London.

If capital restrictions had achieved their aim of insulating monetary developments from events abroad, it might be expected that the variability in exchange rates would be smaller during the period when capital restrictions were in force. A comparison between the period with restrictions (1974–78) and without restrictions (1979–84), however, seems rather to indicate the opposite, although firm conclusions of causality should be avoided. Since 1979, there has been a decline in the variability in the nominal effective exchange rate of the Swiss franc, while the variability in interest rates has remained unchanged. The variability in the nominal effective exchange rate (calculated using the Fund’s multilateral exchange rate model (MERM)), measured as the standard deviation of changes in the natural logarithm of monthly exchange rates, declined on an annual average basis from 1974–78 to 1979–84. A similar development occurred for the deutsche mark, while the variability rose for the pound sterling, the U.S. dollar, and the yen (Table 7). The latter period, however, coincides with the introduction of the European Monetary System, which might also have reduced the variability of the exchange rate of the Swiss franc through its perceived link to the deutsche mark.

Table 7.

Variability of Nominal Effective Exchange Rates and Short-Term and Long-Term Interest Rates

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Sources: International Monetary Fund, International Financial Statistics; and staff calculations.

Standard deviation (multiplied by 1,000) of the change in the natural logarithm of the average monthly MERM (multilateral exchange rate model) exchange rates.

Standard deviation (multiplied by 100) of changes in monthly interest rates.

Domestic three-month rates, except for Japan, where call money rates have been used.

Public bond yields.

The decline in variability of the Swiss franc exchange rate does not appear to have taken place at the expense of higher variability in interest rates. Thus, the variability in long-term interest rates has remained practically unchanged in Switzerland between the two periods, notwithstanding a sharp increase in the variability in Japan and the United States and a notable rise in the Federal Republic of Germany. For short-term interest rates, the evidence is mixed, with a clear decline in the variability of Euro-Swiss franc rates but a significant increase of domestic rates. In both Germany and the United States, the variability in short-term rates rose significantly in the years 1979–84, compared with 1974–78, while it remained almost unchanged in Japan and the United Kingdom.

The more liberal access to holdings of Swiss francs has not increased the role of the Swiss franc as an official reserve currency. The share of the Swiss franc in total identified official holdings of foreign exchange—as estimated by the Fund staff—rose from 2.1 percent at the end of 1978 to a peak of 3.2 percent by the end of 1980 and subsequently declined to 2.0 percent by the end of 1984.39 For a comparison, during the same period, the share of the yen rose almost continuously from 3.3 percent to 5.2 percent, partly reflecting an easing of capital controls in Japan. The share of “unspecified currencies,” however, which especially relate to holdings of oil exporting countries, rose substantially during the same period (from 4.3 percent at the end of 1978 to 11.0 percent at the end of 1984). This implies that the overall official reserve role of the Swiss franc might be underestimated by the identified reserve holdings. The small effect on the official reserve role of the Swiss franc after the removal of restrictions is probably explained, in part, by the limited effectiveness of capital controls before 1979 in satisfying the demand of official Swiss franc holders and, therefore, avoiding pent-up demand for Swiss franc holdings and, in part, by the increase in real returns on U.S. dollar assets after 1979.

Swiss Banking System in the Early 1980s

Since 1979 there have been major shifts in world savings. In the period 1979–81, oil exporting countries experienced substantial net savings which had their counterpart in net dissavings of non-oil developing countries and industrial countries. In the years 1982—85, oil exporting countries registered external current account deficits, while the deficits of non-oil developing countries declined, and industrial countries, excluding the United States, showed growing external surpluses.

This section describes first the changes in liabilities of banks in Switzerland in the early 1980s, especially to oil exporting countries and some Latin American countries and second, the lending exposure of Swiss banks and the intensified supervision by the Federal Banking Commission. The main conclusions are that while the overall share of Swiss banks’ liabilities in BIS reporting banks’ liabilities declined somewhat between 1979 and 1984, a significant increase was observed in their share in deposits of the Middle Eastern oil exporting countries and Argentina and Brazil. This was probably related to the perceived stability of the Swiss banking system during the international debt crisis. On the lending side, Swiss banks have experienced less exposure to high-risk countries than banks in BIS reporting countries. The Swiss banks reduced, in time, their large exposure to Mexico.

Bank Liabilities

In the first half of the 1980s, total bank deposits and fiduciary deposits doubled (in Swiss franc terms) to SwF 342 billion (US$132 billion) at the end of 1984.40 Industrial countries accounted for a declining share of total deposits, while deposits of the Caribbean rose substantially (Table 8). The balance of payments problems of Central American countries (including Mexico) resulted—as expected—in a sizable decline in deposits of those countries. By contrast, the deposits of Argentina and Brazil rose markedly at the same time as the official foreign exchange reserves dropped perceptibly in those countries. Middle Eastern oil exporting countries also increased their deposits with Swiss banks, even after several began to experience balance of payments strains from 1982. In this section, the deposits of both Middle Eastern oil exporting countries and of Argentina and Brazil with Swiss banks are compared with total deposits of those countries in BIS reporting banks.

Table 8.

Bank Deposits and Fiduciary Deposits of Nonresidents with Swiss Banks1

(End of period)

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Source: Swiss National Bank, Das schweizerische Bankwesen.

The categories in the table have been adapted to the published statistics of the Swiss National Bank. The country breakdown of these statistics (which were published in November 1985) was increased to cover 186 countries at the end of 1984.

For the industrial countries the Fund definition is used with the exception that Ireland is excluded (United States, Canada, Australia, Japan, New Zealand, Austria, Belgium, Denmark, Finland, France, Federal Republic of Germany, Iceland, Italy, Luxembourg, the Netherlands, Norway, Spain, Sweden, and the United Kingdom).

Excluding Liechtenstein and gold liabilities; in the Swiss statistics, as from the end of 1984, Swiss banks’ liabilities and fiduciary liabilities to Liechtenstein are considered as domestic rather than external liabilities. For comparison, these liabilities have also been excluded from total liabilities to abroad in the preceding years in this table.

After the second round of oil price increases, the net assets of oil exporting countries rose from US$257 billion at the end of 1979 to US$380 billion by the end of 1983, according to Bank of England estimates.41 The financial assets of oil exporting countries were initially concentrated in liquid assets, such as bank deposits and short-term money market instruments. Subsequently, they were diversified into longer-term placements in bonds, equities, properties, and loans, often on concessional terms, to other developing countries.

By the end of 1983, about 60 percent of oil exporting countries’ assets in all industrial countries was invested in the United Kingdom, the United States, and in the Federal Republic of Germany (Table 9). Most of the remaining 40 percent was probably invested in Switzerland, but a precise estimate is not possible from available data. Thus, there is no information about the amount of Swiss franc-denominated bonds bought by these countries. Equally, there are no figures on purchases of equities and properties by oil exporting countries in Switzerland. Information on oil exporting countries’ placements in Switzerland is largely confined to data on bank deposits and fiduciary deposits by Middle Eastern oil exporting countries with Swiss banks.42 Those countries—as defined in the Swiss banking statistics—include Iraq, the Islamic Republic of Iran, Jordan, Kuwait, Oman, Qatar, United Arab Emirates, Bahrain, Saudi Arabia, the Syrian Arab Republic, the People’s Democratic Republic of Yemen, the Yemen Arab Republic, the Libyan Arab Jamahiriya, and Egypt.

Table 9.

Oil Exporting Countries’ Investment in Industrial Countries

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Source: Bank of England, Quarterly Bulletin(London, March 1985).

Bank deposits of Middle Eastern oil exporting countries with Swiss banks rose from SwF 8 billion at the end of 1978 to SwF 14.9 billion by the end of 1984. The most striking development was the expansion of fiduciary deposits of oil exporting countries with Swiss banks, from SwF 6.3 billion at the end of 1978 to SwF 34.8 billion at the end of 1984 (Table 10). The increase was particularly strong between 1982 and 1984. As a large part of the fiduciary accounts is denominated in U.S. dollars, the increase in Swiss franc terms reflects, in part, the appreciation of the U.S. dollar in that period.

Table 10.

Swiss Banks’ and BIS Banks’ Liabilities to Oil Exporting Countries

(End of period)

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Sources: Swiss National Bank, Das schweizerische Bankwesen’, Bank for International Settlements, International Banking Statistics, 1973–83, and International Banking Developments and Financial Market Developments.

The coverage of BIS reporting banks was substantially widened at the end of 1983, and again changed at the end of 1984, as presented in column B. Data on the old basis are presented in column A.

The coverage of Middle Eastern oil exporting countries follows that of the Swiss National Bank’s statistics; it includes Iraq, Islamic Republic of Iran, Jordan, Kuwait, Oman, Bahrain, United Arab Emirates, Qatar, Saudi Arabia, Syrian Arab Republic, Yemen Arab Republic, Yemen People’s Democratic Republic, Libya, and Egypt.

OPEC countries comprise Kuwait, Libya, Oman, Qatar, Saudi Arabia, United Arab Emirates, Algeria, Ecuador, Gabon, Indonesia, Islamic Republic of Iran, Iraq, Nigeria, and Venezuela.

The Swiss banks’ share of total BIS reporting banks’ liabilities (including Swiss banks’ fiduciary liabilities) to Middle Eastern oil exporting countries stayed at about 12 percent from the end of 1978 to the end of 1981, but in 1982 it rose to 14½ percent and in 1983 to about 17 percent. This suggests a shift of bank deposits to Swiss banks from other banks. A study made by the Bank of England43 shows a sharp reduction in Eurocurrency deposits in the United Kingdom in both. 1982 and 1983, while bank deposits in the Federal Republic of Germany declined only slightly and even rose in the United States (measured in U.S. dollar terms). Although the coverage of oil exporting countries is more comprehensive for the Bank of England data than the Swiss data, it seems plausible that oil exporting countries have shifted funds from the United Kingdom to Swiss banks and U.S. banks. In Switzerland, the increase related only to fiduciary deposits, which are mainly denominated in U.S. dollars. Therefore, there might not have been a currency switch but only a shift from Eurodollar placements in the United Kingdom to Switzerland. The increase in Swiss banks’ share of oil exporting countries’ deposits did not reflect an increase in the total market share of Swiss banks in liabilities of BIS reporting banks. As the increase in liabilities was largely confined to fiduciary liabilities in other currencies than the Swiss franc, the capital movements caused no problem for exchange rate and monetary policies.

In the early 1980s, as mentioned above, the deposits of Argentina and Brazil in Switzerland increased. The share of Swiss banks in total identified bank deposits of Argentina rose from 12½ percent at the end of 1979 to 33 percent at the end of 1983 (Table 11). The in the coverage of BIS statistics. The share of deposits of Brazil has followed an almost identical development, rising from 12 percent in 1979 to nearly 30 percent in 1983, followed by a small decline in 1984. For Argentina, the jump occurred in 1982, the year of severe debt crisis and when the U.K. Government froze Argentinian assets. For Brazil, the rise was particularly large in 1980 and in 1982. For both countries, the largest increase in deposits with Swiss banks has occurred in fiduciary accounts. The increase might be related to shifts in deposits of private residents of those countries—fearing the seizure of their funds in other countries—to match banks’ claims on borrowers from those countries.

Table 11.

Deposits of Argentina and Brazil

(End of period)

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Sources: Swiss National Bank, Das schweizerische Bankwesen; Bank for International Settlements, International Banking Statistics, 1973–83, April 1984 and International Banking Developments and Financial Market Developments; and International Monetary Fund, International Financial Statistics.

The coverage of BIS reporting banks was substantially widened at the end of 1983, which is reflected in data in column B. Data on the old basis are presented in column A.

Lending Exposure

Even before the debt crisis of the early 1980s, external assets of Swiss banks were composed of a relatively high proportion of claims on low-risk industrial countries. At the end of 1979, 69 percent of Swiss banks’ external assets (76 percent including fiduciary assets) were vis-a-vis industrial countries compared with only 56 percent for BIS reporting banks (Table 12). The difference became more marked during the early 1980s, as the share of industrial countries in Swiss banks’ external assets increased to 74½ percent by the end of 1984 (81½ percent including fiduciary assets) while it remained almost constant at 56 percent for BIS reporting banks.44

Table 12.

External Assets and Fiduciary Assets of Swiss Banks and BIS Reporting Banks1

(In percent)

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Sources: Bank for International Settlements, International Banking Statistics, 1973–83, 1984 and International Banking Developments and Financial Market Developments; Swiss National Bank, Das schweizerische Bankwesen.

The categories in the table have been adapted to the published statistics of the Swiss National Bank; figures may not add up because of rounding.

For the industrial countries the Fund definition is used, excluding Ireland for Swiss data but including Ireland for BIS data (United States, Canada, Australia, Japan, New Zealand, Austria, Belgium, Denmark, Finland, France, Federal Republic of Germany, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Spain, Sweden, Switzerland, and the United Kingdom),

From the end of 1984, Swiss banks’ claims and fiduciary claims on Liechtenstein are considered as domestic rather than external assets.

Caribbean includes residual for BIS statistics.

The exposure of Swiss banks to Latin American countries, which peaked at 10½ percent of total external assets at the end of 1980, was almost as large as that of BIS reporting banks (11½ percent at the end of 1980). However, by contrast to BIS reporting banks, which maintained their relative exposure up to the end of 1984, Swiss banks reduced their lending in both nominal and relative terms, especially in 1981 and 1982, to 6 percent of external assets by the end of 1984 (Table 12). Lending to Central America (e.g., Mexico) was cut sharply in those years, but exposure to other Latin American countries, including Argentina and Brazil, was also reduced somewhat.

In line with the overall trend in BIS bank lending, Swiss exposure to Eastern European countries was halved from 3½ percent to 1½ percent of their total external assets between the end of 1979 and the end of 1984. The exposure of Swiss banks in Africa, at about 3–3½ percent of external assets, was almost the same as the exposure of BIS reporting banks. No significant change has taken place in this share in recent years.

The debt crisis of the early 1980s prompted the Federal Banking Commission to intensify its supervision of banks’ country risk. In its Annual Report for 1983, the Commission described a selected survey conducted among Swiss banks at the end of 1982 on country risk measured on a consolidated basis. It concluded that Swiss banks had lower risk exposure and better capital coverage than banks in several other countries. At the end of 1982, the exposure to 60 high-risk countries amounted to SwF 23 billion (US$11½ billion at the end of 1982 exchange rate); about 60 percent of this lending was to Latin American countries. High-risk lending was concentrated in the big banks and in foreign-owned banks which were most heavily engaged in foreign lending. On average, risky lending was below banks’ own capital; however, for a number of foreign-owned banks, high-risk lending exceeded substantially their own capital.

On the basis of information on the risk evaluation and provisioning of some Swiss banks with long-lasting experience in international business, the Federal Banking Commission formed a judgment on evaluating country risk by Swiss banks. In early 1983, it requested that Swiss banks make 20 percent provisioning for lending to countries which were defined as risky and that this percentage be reached in the course of two to three years for the banks which were currently below that ratio. In its Annual Report for 1984, the Commission concluded that by the end of 1984 all Swiss banks were following that recommendation.45

Switzerland’s Competitiveness as an International Financial Center

Switzerland has never competed with other major international financial centers in terms of the overall volume of transactions. Its strength has been specialization, especially in the international bond market, in portfolio management, and in trade in precious metals. In recent years, competitiveness has increased in international banking. Capital restrictions have been reduced in the Federal Republic of Germany, France, and Japan. Deregulation in major financial centers has shifted part of international business to domestic markets, reducing Switzerland’s traditional comparative advantage of having a universal banking system. The repeal of the withholding tax on interest income from securities of nonresidents in the United States in mid-1984 followed by similar moves in France and Germany has also reduced the competitive advantage of Switzerland as a financial center. Moreover, recent trends in international banking show a move away from expansion of balance sheet transactions toward fee- the Swiss National Bank. The and commission-generating off-balance-sheet items, another traditional specialty of Swiss financial business. At the same time, new financial instruments have proliferated, including floating rate notes, note issuance facilities, Eurocommercial paper, and interest and currency swaps. These developments, combined with increased use of advanced telecommunications and computers, have undoubtedly exposed Swiss financial institutions to increased competitiveness.

A market share analysis for international financial transactions is only possible to a limited extent. Table 13 shows the share of Swiss banks’ external assets (including fiduciary assets) in BIS reporting banks’ assets. From 1974 to 1981, the share of Swiss banks’ assets in BIS reporting banks’ external assets remained almost unchanged at 13–14 percent, if adjustment is made for a widening in the coverage of BIS data. In 1982 and 1983, however, the Swiss market share declined by some 1½ percentage points and stayed roughly unchanged in 1984 (also corrected for changes in BIS data coverage). Is this decline to be interpreted as a deterioration in competitiveness? The figures, by nature, indicate only the magnitude not the quality of the transactions. As mentioned, Swiss banks reduced sharply their exposure to Latin American countries in 1981 and 1982 in contrast to BIS reporting banks. The decline in the market share of Swiss banks’ external assets might therefore reflect withdrawal by Swiss banks from lending to high-risk countries. The period of observed decline in market share also coincides with the large appreciation of the U.S. dollar against the Swiss franc and other currencies and might therefore, in part, reflect valuation changes of external assets. In addition, these figures fail to capture the substantial amounts of off-balance-sheet transactions (except fiduciary accounts), which are highly important for Swiss banks and for which comparable data are not available.46

Table 13.

Swiss Banks’ Market Shares in BIS Reporting Banks1

(End of period)

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Sources: Bank for International Settlements, International Banking Statistics, 1973–83, and International Banking Developments and Financial Market Developments; Swiss National Bank, Das schweizerische Bankwesen.

Two sets of figures for BIS reporting banks (A and B) refer to a break in the statistical coverage.

Swiss financial institutions have traditionally catered to portfolio management of private persons rather than institutions. In recent years, however, there has been a significant shift in savings from individuals toward institutions (e.g., social security funds) in both Switzerland and abroad. As individuals and institutional investors have different needs for portfolio management, a reorientation in the services offered by Swiss financial institutions has been required. The turnover in the portfolio of institutional investors is usually relatively high. In that case, taxes on financial transactions play a crucial role for the attractiveness of Switzerland compared with other centers.

The repeal in several countries of the withholding tax on interest income on securities held by nonresidents has fueled the debate in Switzerland on taxation of securities transactions. The taxation takes two forms: a withholding tax on interest income and a stamp duty on all securities transactions. These taxes have been introduced for fiscal reasons rather than to prevent capital inflows. The withholding tax on interest income, at 35 pecent, is high by international comparison (Appendix III) and applies to all capital earnings, including interest income on domestic bond issues (i.e., the borrower is a Swiss resident) and on bank deposits. Interest income on foreign bond issues in Switzerland (i.e., the borrower is a nonresident) and on fiduciary deposits, however, is exempt from the withholding tax.47 The different treatment of financial transactions with respect to withholding tax has led to a shift from regular bank deposits to fiduciary deposits and presumably also to a shift in demand from domestic to foreign Swiss franc issues. However, as foreign bond issues are exempted, the shift does not cause a competitive disadvantage for foreign bond issues in Switzerland compared with issues in other countries.

The stamp duty is a major reason for the lack of a developed money market in Switzerland (as described in Section IV). It has also prevented Swiss banks from participating actively in trading in Eurobonds in Switzerland; those transactions have been conducted via their branches and affiliates abroad. The stamp duty is a particular disadvantage compared with banks in Luxembourg and the United Kingdom, where no taxes on Eurobond trading exist. Security transactions by dealers in Switzerland are also subject to the stamp duty; in most other countries, dealer transactions are exempted from security taxes (Appendix III). The Swiss Government may consider changing the stamp duty to secure a neutral impact on federal revenue.48 Should that happen, the Government will have to weigh the relative merits of maintaining a secure source of fiscal revenue—which, however, would impair international competitiveness of the Swiss financial market—against the possibility of reducing the stamp duty, which might attract international business to Switzerland and generate increased tax liabilities of financial institutions and private persons and would thus compensate, at least in part, for the shortfall in revenue from the stamp duty.

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