Switzerland—2011 Article IV Consultation Conclusions of the Mission
March 28, 2011
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Switzerland is experiencing a strong expansion. While inflation remains muted, slack in the economy is disappearing. Absent significant shocks, the monetary authorities should be in a position to tighten in the near term. As normalization of interest rates may not fully correct mortgage market tensions, the authorities will need to curb risky lending practices through macro-prudential policies. More fundamentally, there is a need for the authorities to strengthen legal clarity on how system-wide (“macro-prudential”) risks should be identified and addressed. Ongoing efforts to strengthen financial supervision and regulation are commendable and should be pursued. Swift adoption by Parliament of the “too big to fail” proposal would be a major contribution in reducing the risks created by the two large banks.
1. Switzerland is experiencing a strong post crisis recovery—despite a marked exchange rate appreciation. Output and employment are now above pre-crisis levels. The recovery has been broad based. Domestic demand has been supported by sound balance sheets, low interest rates, a rise in employment and immigration, while exports have picked up as a result of the rebound in world demand and in spite of the Swiss franc appreciation. With capacity utilization measures at, or above, their long-run averages and the unemployment rate close to 3 percent, output gap estimates suggest little slack in the economy. Moreover, trade and current account surpluses continue to expand.
2. The mission expects growth to moderate over the year. While domestic demand should remain resilient, currency strength and an expected weaker external environment should slow exports. After expanding by 2.6 percent in 2010, GDP should grow by 2.4 percent in 2011 and 1.8 percent in 2012. Inflation is expected to remain muted at around 1 percent in 2011–12 as wage demands remain subdued and the effects of higher energy prices are dampened by the nominal appreciation. Survey data also suggest price expectations remain well-anchored.
3. While risks appear broadly balanced, the outlook is subject to high uncertainty. Better than expected growth in trading partners or a reduction of Euro area debt concerns would constitute upside risks. Recent foreign developments could constitute downside risks if they result in further increase oil prices or disrupt supply chains, as would renewed tensions in the Euro area, which could also put pressure on the currency. So far, the economy has absorbed past appreciation well, as exporters have compressed their margins. While stronger–than-expected exports may reflect structural changes (e.g., an increased orientation towards emerging economies), a delayed effect of past appreciation may materialize. Growth could also be affected by a slow down in currently buoyant construction activity. The recovery prospects of financial intermediation are also uncertain.
Monetary and Exchange Rate Policies
Under the current scenario, monetary authorities should be in a position to raise interest rates in the near term.
4. The SNB has maintained a near-zero interest rate since January 2009 and intervened on the foreign exchange market from March 2009 to June 2010. In the spring of 2010, faced with a surge in capital inflows, the SNB stepped up its interventions in foreign exchange markets. Since then, the Swiss franc real effective appreciation has accelerated, resulting in a 10 percent increase between March 2010 and February 2011.
5. Absent significant shock, notably on the currency, the SNB should be in the position to start tightening the policy rate in the near term. The recovery has firmed, and slack in the economy is disappearing. With ample liquidity available, the growth of monetary aggregates is high. Inflation expectations remain well anchored but the current interest rate stance is unsustainable in the medium-term. Exiting the prolonged period of near zero interest rate will also contribute to reducing macro-financial concerns, including a loosening of mortgage lending standards. Since this effect is likely to be only limited, concerns related to mortgage lending should be addressed by macro-prudential instruments.
6. Interventions on the foreign exchange market, if any, should be limited to smooth disorderly movements of the exchange rate. While the Swiss franc is on the high side in a historical perspective, continuing robust trade performance and large current account surpluses suggest that the currency is still broadly aligned with medium-term macroeconomic fundamentals.
7. In the medium term, the SNB will adjust the size of its balance sheet and should give priority to strengthening its capital. Like many central banks, the SNB is exiting the crisis with an inflated balance sheet and a weaker capital position (16 percents of assets at end-2010, compared to 51 percent at end-2007). The level of international reserves and of capitalization should be commensurate with the size and international activities of the financial sector. Future distributions of gains to the Cantons and Confederation should be subject to the ability of the SNB to replenish it capital.
Although the fiscal position has remained sound, reforms to improve long term sustainability remain necessary.
8. The fiscal position has been little affected by the crisis. With limited fiscal stimulus measures and automatic stabilizers, Switzerland is exiting the crisis with comparatively strong fiscal balances. The central government recorded a surplus of about ½ percent of GDP in 2010, and expects close-to-balance positions in the next few years. The objectives of the debt brake rule have been exceeded due to stronger-than-expected revenues and under-spending, and the general government debt-to-GDP ratio is now around 53 percent of GDP on a GFSM basis.1 At the general government level, the 0.3 percent of GDP surplus is projected to gradually increase to around ½ percent of GDP over the 2011-13 period. In this context, and in accordance with the debt brake rule for the Confederation, the fiscal stance is expected to be broadly neutral in the years to come.
9. A sound fiscal position has served the country well and should be preserved. Fiscal prudence is warranted especially for a country with a large financial sector, and in view of ageing pressures. At this juncture, and given the need for a gradual tightening of monetary policy, a neutral stance is appropriate. Looking ahead, adherence to the debt brake rule should help preserve this sound position. Implementation of the rule will be supported by ongoing efforts to improve the accuracy of budget planning both on the revenue and on the expenditure side, and to develop performance budgeting. Attention should also focus on medium term challenges. Measures to limit disability insurance deficits should be complemented by reforms to ensure sustainability of public finances, including a parametric reform of the old age insurance system.
Financial Stability Issues
The financial sector is benefiting from economic recovery, but some risks have to be addressed.
10. In the banking sector, performance has improved thanks in part to the favorable economy and accommodative monetary conditions, but challenges lie ahead. Swiss banks generally reported higher profitability, better asset quality, and stronger capital and liquidity buffers in 2010. Though their Tier1 capital ratios compare favorably with peers, large banks remain relatively more leveraged and dependent on wholesale funding, and have large cross-border exposures. Risks for other banks are more concentrated in mortgage lending (see below). Banks will have to adapt to regulatory changes, which will weigh on their profitability. In addition, private banking activities will need to continue to adapt to higher standards on client tax compliance, and consolidation in the sector may occur.
11. The development of lax lending standards in the mortgage market and increasing interest rate risk call for pre-emptive measures. While overall housing prices have not accelerated so far as in a typical real estate bubble, there is evidence of declining lending standards in the market. In addition, the sensitivity of banks balance sheets to interest rate risk has increased, as fixed-rate longer maturity mortgages are becoming more common. Preventive action is warranted to address both financial stability and social concerns. Part of the solution lies in stepped-up micro-prudential measures, such as capital add-ons for banks with lax practices. However, system-wide measures should also be envisaged unless self-regulation is sufficiently stepped up and addresses all financial institutions engaged in mortgage lending. Possibly useful measures include imposing maximum loan-to-value ratios, as implemented in other countries, requiring more conservative affordability assessments, or imposing system-wide capital add-ons based on mortgage lending evolutions.
12. In the insurance sector, the full implementation of the Swiss Solvency Test (SST) is welcome while risks should continue to be monitored and managed. The SST has come into full effect since the beginning of the year and some corrective measures have been enforced to improve the solvency positions of companies that have failed the test. Some insurers may find it challenging to boost their capital because of the subdued profitability prospects and the need to strengthen reserves. Insurers—particularly in the life insurance industry— have relatively high exposures on Swiss real estate market, while their exposure to Euro area countries where debt concerns have arisen is more limited. Preliminary estimates of the claims from Japanese catastrophe suggest that they are manageable. Risks associated with mortgage lending, and certain products warrant continued close monitoring. Pension fund performance has improved, but under funding remains, especially for funds with a public guarantee, which would call for adjustment measures to restore funding ratios.
Continued efforts will be needed to upgrade financial sector regulation and supervision, building on the considerable progress to date.
13. While regulatory reforms are well under way, the adoption by Parliament of the too-big-to fail (TBTF) draft legislation would be instrumental in reducing the risks related to the two large banks. Early in the crisis the authorities expanded supervision of the large banks, increased capital top-ups on Basel II requirements, added a maximum leverage ratio, and introduced remuneration guidelines aimed at reducing excessive risk-taking. In 2010 they also introduced a new liquidity requirement on the two largest banks. Within the coming weeks the Federal Council is expected to send to Parliament a draft law that would, inter alia, substantially increase capital buffers held by the two large banks. Such buffers would be key to reduce the risks posed by systemic institutions and a lax interpretation of the possibility of a “rebate” should be avoided.
14. Progress made in stepping up supervision efforts, including ensuring proper supervision of cross-border institutions, is welcome and should continue. FINMA has increased its on-site inspections, hired more personnel, and taken measures to strengthen the effectiveness of external auditors. These efforts are welcome and further progress in these areas should be made to ensure that FINMA lives up to best international standards. Areas where FINMA should also continue its efforts to improve include: strengthening the independence of regulatory auditors from banks and allowing FINMA to define their mandates, ensuring resources for the enforcement function in line with international peers, and moving to supervise unsupervised entities if they pose a significant risk.
15. The macro-prudential framework should be strengthened and roles and responsibilities of the SNB and FINMA should be clarified. As suggested by ongoing discussions surrounding the situation on the mortgage market, the framework for using “macro-prudential” policies largely remains to be defined. The respective mandates of the SNB and FINMA could usefully be clarified, where necessary by revising relevant legislation, and the legal basis for system-wide policies should be strengthened. While there is no single international model for such a framework, authorities should attempt to utilize the expertise and resources of both FINMA and the SNB.
We thank the authorities and all our other counterparts for their hospitality and the open and fruitful discussions.
1 On an ESA95 (Maastricht) basis it is under 40 percent of GDP.