The key to the future of Swiss banking is full structural separation of commercial and investment banking.
This separation can be achieved by an amendment to Art. 98 of the Swiss Constitution which stipulates, that the Confederation shall legislate on the banking and stock exchange system in a way, that separates the issue, flotation, underwriting, public sale and trading of securities and financial derivatives from commercial banking and wealth management.
What started as a crash in the american credit markets six years ago, became a full blown crisis of world finance and world economy. The explanations for this are much different, and fill websites and libraries of economists and politicians. But as different as they are, one fact is clearly established. Many national governments and central banks were, contrary to their usual economic policy, forced to intervene and save their biggest banks. These systemically important financial institutions are so large, that their failure would have had a catastrophic effect on the stability of their country’s financial system. They were too big to fail. Some of these banks are state-controlled until today. Others are getting indirect government assistance via the the unconventional methods of their central bank’s expansionary monetary policy. These unconventional methods were implemented in order to stabilize the banking system and include central bank enforced zero short-term interest rates, exerted pressure on medium and long-term rates, and the so called quantitative easing, that is central banks buying bonds from the own treasury to finance the deficit.
Such monetary policy was able to save too big to fail banks from bankruptcy, but only at the price of dangerous addiction. They failed to deliver growth to the real economy as intended. In many countries unemployment growed to historic heights, while world trade is stagnating and the European crisis deepens. The unconventional crisis management of governments and central banks produced unwanted consequences threatening to get out of hand.
There are two possible solutions in a situation like this. Either to carry on with the unconventional and rebaptize it as the new normal. Or to confront oneself with the roots, draw conclusions.
So far, the Swiss economy has shown a remarkable resilience to the financial crisis. There is a little growth. Unemployment is low, debt levels are deep, and where rising sustainable. The banking sector has digested the crash of it’s number one, thanks to the helping hand of the State. According to newly enacted legislation the too big to fail banks, UBS and Credit Suisse, trimmed their balance sheet, expanded their loss-absorbing capital and reduced their risks in securities and derivatives trading. Their biggest challenge lies in private banking, where the world no longer accepts traditional Swiss banking secrecy. While banking shrinked, commodity trading and the insurance business expanded.
Swiss National Bank (SNB) addressed two major problems of Swiss domestic economy, a job-killing strong currency and a looming real estate bubble, with two new instruments of its monetary policy. Firstly the absolute defence of the minimum exchange rate of CHF 1.20 against the Euro. And secondly the so called countercyclical capital buffer, a flexible instrument that increases the loss absorbing capacity of the banking system by demanding more capital.
Securing the minimum exchange rate remains geared to SNB’s monetary policy for the foreseeable future. In other words SNB must limitlessly buy Euros against newly created central bank money whenever Euro holders search a safe haven against their weakening currency. Which increases the monetary aggregate M0 and translates into an increase for M1, M2 and M3 aggregates, that measure the amount of money held by households and companies. To deny the inflationary potential of this constellation is wishful thinking.
The most serious downside of SNB’s monetary policy however, is its effect on UBS and Credit Suisse. SNB strengthens these two private global banking giants, which are still vastly oversized in relation to the Swiss real economy. On the one hand by the zero interest rate policy. And on the other hand by letting them benefit from its big demand for services in the foreign exchange business. Monetary policy thus aggravates the too big to fail problem, which Swiss government and parliament tried to solve. As long as UBS and Credit Suisse can count on a helping hand from SNB, higher capital requirements, predetermined breaking points and living wills can not solve the too big to fail problem. The solution of this dilemma lies in a structural reform of the banking system. According to Swiss law and constitution such a reform is clearly the business of politics, not the central bank. Because the banking sector transmits the monetary policy to the real economy, such a reform will also redefine the foundations of central banking.
The actual crisis has brought the centennial success story of the Swiss universal bank model to an end. What Switzerland needs is full structural separation of investment and commercial banking. This would not only solve the too big to fail problem, but also inject trust and stabilisation to the much differentiated domestic banking landscape. And could be an important driver for a repositioning of Switzerland as a global financial centre. With its burning problem to adapt traditional banking secrecy to changing standards in global wealth management.
Commercial banking, that is to say deposit taking and lending to households and small and medium enterprises are mainly driven by factors of the domestic real economy. Investment banking is driven by risky events on the global financial markets of securities and derivatives. And international wealth management is driven more and more by geopolitics. A separation of these businesses would reduce the danger of cross-contamination of risk by strengthening the distinct cultures of riskier investment banking and less risky commercial banking. The conflicts of interest between these much different businesses were always here, six years of financial crisis have brought them to the open.
The bankruptcy of Lehman Bros. a now defunct US-american investment bank, and the following rescue of countless banks by governments and central banks in September 2008 opened a global discourse of the pros and cons of a separation of investment and commercial banking. In the United States, the so called “Volcker rule” became law in July 2012, banks have two years to comply. This rule prohibits US-operating banks from undertaking proprietary trading and restricts potentially risky private equity activity. In the United Kingdom, the proposals of the “Vickers Commission” are in discussion. Legislation is planned by 2015. These proposals include placing a ring-fence around retail banking activities and overdraft, supported by higher levels of capital. The EU announced the so called Liikanen plan in October 2012. It proposes that certain investment banking activities of universal banks be placed in a separate entity from the rest of the banking group. In some EU-member states, for example Germany and France, new laws based on the Liikanen proposals entered the parliamentary discussion.
The Volcker, as well as the Vickers and Liikanen plan differ, because they are built around the specific conditions of their economic spaces. Common ground however is that they do not propose full, but only partial separation. These plans are no modern versions of Glass-Steagall Act, the famous banking separation law enacted by US-Congress 1933.
In Switzerland the discussion of the too big to fail problem began with a bang and has passed away pretty much since. 2009 after the forced rescue of UBS there was an unparalleled joint declaration of Christoph Blocher, then president of rightwing Swiss People’s Party, Nicolas Hayek, the now deceased founder and owner of Swatch, and Christian Levrat, the actual President of the Swiss Social Democrats, calling jointly to split up UBS and Credit Suisse. But since then most experts from academia, government and the banks, as well as most politicians dismissed the idea of separating commercial and investment banking. With a little help from the banking lobby the idea was rarely discussed in the media, and finally, government and parliament seeked salvation in stricter capital requirements, living wills and prearranged reorganization in case of bankruptcy.
That’s a pity. A full structural reform of the Swiss Banking System has more winners than losers. The winners are stability and growth, as well as trust and reputation. The losers are the vested interests in the old system.
Full separation is a clear and simple idea, operationally simple to implement. This is a cardinal advantage, especially for Swiss Parliament, where every single article of every new law must be discussed in plenum. And further reduces complexity once in place. No need of implementation rules with tens of thousands of pages.
Full separation is a way out of the impasse in private banking, where the world no longer accepts traditional banking secrecy. A few years ago Swiss government proudly declared banking secrecy to be non-negotiable, a nut too hard to crack for anyone. Just ask the Habsburg’s what non-negotiability in Switzerland means. Banking separation is a way to move forward without losing face.
Concerning UBS and Credit Suisse, they would perish in their present form all right. But this implies neither the loss of all jobs, nor the opportunity to run profitable global banking operations in Zurich, Geneva and Lugano. Quite the reverse. Based on their 150 years of know how in international finance they could innovate in the field of global investment building. And build a new type of global securities transaction bank based on the traditional strenghts of their location, like reliable infrastructure, legal certainty, political stability, high living standard, and last but not least political neutrality.
It’s simple. And its a recipe for qualitative growth of the economy, meaning socially acceptable and ecologically compatible new jobs. All it takes is an amendment to Section 1 of Art. 98 of the Swiss constitution about Banks and insurance companies:
Art. 98 1 The Confederation shall legislate on the banking and stock exchange system; in doing so, it shall take account of the special function and role of the cantonal banks.
The legislation shall separate the issue, flotation, underwriting, public sale and trading of securities and financial derivatives from commercial banking and wealth management.