## _cr14142

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---

### Context
- Swiss economy regained momentum; monetary and exchange rate conditions not normalized.
- No foreign exchange intervention since 2012; currency remained close to SNB floor imposed in 2011.
- Policy rate at zero and abundant excess liquidity have contributed to mortgage market imbalances.
- Structural and medium-term pressures:
  - Erosion of bank secrecy.
  - Need to reform corporate taxation favoring foreign operations.
  - Popular vote approved curbs on immigration, endangering free movement and accelerating population aging.
- Large financial sector: marked improvement since Global Financial Crisis; FSAP Update recommends additional regulatory, oversight, and safety net measures.

### Recent Economic Developments and Outlook — A. GDP Growth and Inflation
- 2013 GDP growth: 2.0 percent.
- 2012 GDP growth: 1 percent.
- Drivers in 2013: private consumption (wage increases and negative inflation raising real disposable income), construction rebound, improving external sector.
- Unemployment rate: 3.2 percent.
- Net immigration: some 1 percent of population (highest since 2008).
- Price developments:
  - After two years of deflation, price growth hovering around zero.
  - Negative inflation from foreign goods and services offset by positive domestic inflation.
  - Inflation expectations remain well anchored in positive territory.
- Exchange rate and SNB balance sheet:
  - Franc traded in a 1.22–1.25 band relative to the euro during July 2012–April 2013.
  - CHF/EUR appreciation since April 2013; franc movements close to the floor during volatility episodes.
  - SNB balance sheet around 80 percent of GDP.

### Recent Economic Developments and Outlook — B. Housing, Mortgages, and Banking
- Banking sector:
  - Large banks’ balance sheets continue to shrink; domestically-oriented banks grown substantially with rising real estate lending.
  - Overall banking sector: well capitalized and profitable.
- Real estate and mortgage indicators:
  - Prices of owner occupied apartments rising at 6 percent per year on average since 2008.
  - Real residential prices above early 1990s peak.
  - Mortgage debt above 140 percent of GDP at end-2013.
  - Average mortgage maturity: about 5 years with frequent rollovers.
  - Mortgage growth in buy-to-let sector accelerating; non-mortgage corporate lending subdued.

### Recent Economic Developments and Outlook — C. Fiscal Position
- General government budget close to balance in 2013.
- Federal balance deteriorated somewhat relative to 2012.
- Reforms to unemployment insurance and a VAT increase for invalidity pensions kept social security funds in surplus.
- 2014 fiscal stance expected broadly neutral; general government small deficit reflecting lack of SNB profit distribution and one-off cantonal pension restructuring contributions.
- Structural balance expected close to zero beyond 2014; debt-to-GDP ratio should fall to 44 percent of GDP in 2017 (GFSM-basis).
- Medium-term spending pressure from population aging: peak at about 4 percent of GDP by 2055.

### Outlook and Risks
- Baseline projections:
  - 2014 growth: 2.1 percent.
  - 2015 growth: 2.2 percent.
  - Inflation expected to rise gradually; output gap to close progressively.
- Upside risk: stronger global recovery raising external demand.
- Key downside risks:
  - Disorderly exit from unconventional monetary policy causing global volatility and safe haven inflows.
  - Protracted EM turmoil.
  - Re-emergence of euro area financial stress.
- Domestic risk: mortgage market imbalances building since 2007; domestically-oriented banks vulnerable due to concentrated mortgage exposure.
- FSAP stress tests:
  - Domestically-oriented banks well capitalized under scenarios, including a housing crash (limited by data availability).
  - Two large banks: highly leveraged and interconnected; under phase-in Basel III they comfortably exceed capital requirements, but under most severe scenario capital ratios could fall below 7 percent under fully implemented Basel III definition.
  - Almost all banks satisfy LCR requirement, helped by unusually high central bank deposits.
- Contingent fiscal liabilities: existing capital buffers should be sufficient to absorb severe macroeconomic shock losses; limited fiscal contingent liabilities implied.
- Financial-sovereign spillovers: contagion from banks to sovereign contained at present.

### Policy Discussions — A. External Sector Assessment
- 2013 current account:
  - Preliminary surplus: 13 percent of GDP (3.4 percent of GDP increase over 2012).
  - Staff estimate: current account surplus around 9½ percent of GDP for 2013 to reflect likely downward revisions.
- Drivers: modest goods balance improvement, softened services exports, bulk increase due to net investment income (volatile).
- Factors possibly overstating surplus:
  - Merchanting by international commodity trading companies ~3 percent of GDP contribution.
  - Retained earnings of multinationals partly attributable to foreign shareholders.
  - Cross-border shopping and mail/courier deliveries may understate imports.
  - Profit shifting and booking in low-tax financial centers may inflate net exports.
- Staff assessment: current account broadly in line with fundamentals; franc estimated 7 percent overvalued (External Balance Assessment).
  - REER-ULC appreciated by 2.6 percent since end-2012 and cumulatively by 1.3 percent since end-September 2011.
- Authorities: concur on difficulty interpreting current account and expect statistical changes with BPM6 adoption in June 2014; noted overvaluation may be larger depending on methodology.

### Policy Discussions — B. Monetary and Exchange Rate Policies
- Recommendation: "The floor should remain in place for now to guard against deflationary risks."
- Policy objective: anchor inflation expectations while avoiding excessive tightening from exchange rate appreciation; requires careful calibration of unconventional instruments.
- Scenarios and prescriptions:
  - Upside (global recovery): safe haven flows revert; SNB should gradually reduce foreign exchange holdings with clear communication; raise policy rate if inflation threatens to move above comfortable levels even if balance sheet not returned to pre-crisis level.
  - Downside (disorderly UMP exit, euro-area risks, EM sell-off): keep floor in place; consider negative interest rate on bank excess reserves to discourage inflows.
  - Domestic adverse shocks: negative interest rates might address deflationary pressures; monitor impact and reinforce macroprudential measures to avoid worsening mortgage imbalances.
- SNB balance sheet and provisioning:
  - SNB announced sizable valuation loss on gold holdings, first suspension of profit transfers.
  - Build-up of risk provision stepped up in 2011 but has not kept pace with balance sheet increase.
  - Recommendation: "provisioning should receive priority over transfers to the distribution reserve."
  - Authorities view: floor essential; negative rates on excess reserves a possible tool; current profit distribution arrangements seen as sufficiently protective of capital.

### Housing Market Measures, Assessment, and Recommendations
- Measures taken 2012–2013:
  - Swiss Bankers Association minimums (effective mid-2012):
    - Down payment of 10 percent of lending value from borrower’s own funds (not via pledging/early withdrawal of Pillar 2 pension assets).
    - Mortgages must be paid down to two thirds of collateral value within maximum of 20 years.
  - FINMA tightened risk-weighting for new/renewed mortgages for IRB banks (effective 2013).
  - Federal Council measures (effective 2013):
    - Non-compliant mortgages allowed but subject to 100 percent risk weight.
    - Mortgages exceeding 80 percent of property value: 100 percent risk weight on portion above 80 percent.
  - Counter Cyclical Capital Buffer (CCB):
    - Activated to "1 percent CET1 capital by end–September, 2013" and raised to 2 percent in January 2014 (to be fulfilled by end-June, 2014).
- Assessment: measures welcome but "have been only partially successful."
- Observed facts:
  - House price growth: 6 percent per year average since 2008; 4.3 percent year-on-year in second half of 2013.
  - Limited cooling in mortgage growth; mortgages to buy-to-let companies accelerated in 2012–13; quantitative surveys show no or limited reduction in DTIs or LTVs.
  - Distribution of wealth and mortgage debt across households not available.
- Recommendations:
  - Consider direct regulatory measures targeting affordability and LTVs.
  - Stronger measures to curb mortgage demand needed in very low interest rate environment.
  - If self-regulation (faster amortization and larger cash down payments) not achieved, introduce direct regulation on maximum DTIs and LTVs.
  - Put in place parallel measures to curb mortgages to income-producing real estate companies.
  - Supervisors should use Pillar II measures proactively to address concentration and interest rate risks.
  - Reduce or eliminate tax deductibility of mortgage interest.
- Authorities’ view: agree imbalances expanded but measures had calming effects; increase in CCB informed by concerns; affordability measures under discussion; political support for mortgage interest taxation reform elusive.

### Financial Stability, TBTF Banks, and Resolution
- Two large banks strengthening capitalization and restructuring; leverage ratios remain low relative to other large global banks.
- End-2013 status:
  - Both banks above "10 percent minimum CET1 capital ratio in the Swiss Too-Big-Too-Fail (TBTF) legislation to be met by 2019."
  - Leverage ratio progress slower; both below fully-implemented Swiss minimum leverage ratio.
  - Liquidity: Basel III LCR and NSFR exceeded at end-2013.
  - Profitability in 2013 but legal risks (mortgage mis-selling, U.S. tax cases, LIBOR/FX activity) present.
- Recommendations:
  - Rapidly bring leverage ratio in line with other major international banks.
  - Ensure minimum leverage requirements ambition beyond international minima in level and capital quality.
  - FINMA examination of internal-model vs standard approach risk-weights welcome; review model approvals where differences large.
  - Priority: make TBTF resolution regime robust and workable cross-border; finalize strategy for resolvability without government support; reach cooperation agreements with U.S. and U.K. authorities.

### Banking Supervision and Deposit Insurance
- Supervision:
  - Need to strengthen supervision of domestic banks and shore up FINMA resources.
  - FSAP Update: high compliance with Basel Core Principles but FINMA operates with resources well below other supervisors.
  - Recommendations: provide more guidance to external auditors, harmonize supervision, complement auditor work with "deep dives", rotate audit firms at least every five years, pay auditors from a FINMA-administered fund.
- Deposit insurance:
  - "The Swiss deposit insurance system needs substantial reform."
  - FSAP proposals: greater transparency, commitment to faster payouts, ex ante financing, fund powers to take actions other than bank closure.
- Authorities’ view: consider supervision adequately funded and executed; deposit insurance reform prospects limited; recent reform effort lacked political consensus.

### Medium-term Prospects: Immigration, Aging, Tax, Secrecy
- Immigration referendum: popular vote to re-establish quotas; Federal Council has three years to implement.
  - Free movement had increased labor force by about one percentage point per year; reduced immigration could ease housing pressure but worsen aging dynamics and investment prospects.
- Pension reform "Pension 2020":
  - Harmonize retirement age at 65 (men and women).
  - Flexible transition from age 62 and cut early retirement benefits.
  - Introduce sustainability rule for social security funds (automatic adjustments if funding ratio falls below 70 percent and deficits exceed 3 percent for two consecutive years).
  - For Pillar II: reduce minimum conversion rate from "6.8 percent to 6 percent".
  - Financing: "A two percentage point increase in the VAT and higher social security contributions would finance the cost."
  - Staff view: aligning retirement ages appropriate; fiscal rule for social security funds should reduce fiscal risks.
- Corporate tax and bank secrecy:
  - Reform special tax regimes for foreign activities envisaged "as of 2018."
  - Recommendation: design new regime considering BEPS initiatives.
  - Recommendation: implement FATF and Global Forum standards (criminalization of tax crimes as predicate to money laundering, transparency of legal persons, due diligence for PEPs).
- Authorities’ view: optimistic about pension reform; parliamentary enactment expected by 2020; building federal buffers for corporate tax reform revenue losses; progress on AML-CFT and FATF implementation with FATF Evaluation to start in fall 2014 and be finalized in 2016.

### Annex — Surges in Global Financial Volatility and the Swiss Franc
- Safe-haven flows re-affirmed during global turbulence (e.g., May 22, 2013 "taper talk" and January 2014 EM concerns).
- Switzerland received largest global mutual fund inflows as percent of GDP since end-2013 (EPFR Global chart referenced).
- 10-year sovereign yields peak Δ after May 22 taper talk (basis points):
  - CHE 29; Avg. 32; DEU 30; USA 49; JPN -2; GBR 50.
- Δ since start of 2014:
  - CHE -30; Avg. -32; DEU -41; USA -33; JPN -10; GBR -44.
- Levels as of March 14, 2014:
  - CHE 94; Avg. 190; DEU 151; USA 266; JPN 64; GBR 280.
- G20MOD simulation (fully flexible exchange rate adverse scenario):
  - Assumes 100 basis point sovereign risk premia increase for stressed euro area economies and EMs over 2014–17 and average franc appreciation of 5 percent in 2014–15.
  - Real GDP percent deviations from baseline (Switzerland):
    - 2014: -0.60
    - 2015: -1.51
    - 2016: -1.60
    - 2017: -1.04
    - 2018: -0.11
  - Headline inflation percent point deviations (Switzerland):
    - 2014: -0.48
    - 2015: -0.60
    - 2016: -0.43
    - 2017: -0.32
    - 2018: -0.05
  - Swiss REER percent deviation from baseline:
    - 2014: 4.96
    - 2015: 5.61
    - 2016: 3.43
    - 2017: 1.18
    - 2018: -2.25
- Interpretation: under this scenario inflation falls below zero in 2014–15 and output losses peak at 1.6 percent in 2015; underscores role of exchange rate floor.

### IMF Executive Board and Directors’ Views (selected)
- Exchange rate floor necessary to guard against deflationary risks; monetary conditions should remain expansionary.
- Directors encouraged considering negative interest rates on excess reserves if appreciation-driven deflation risks arise while reinforcing macroprudential measures.
- On housing: welcome measures taken; advised groundwork for stronger actions (tax reforms, direct regulation on affordability and LTVs) and to continue monitoring.
- On financial sector: encourage large banks to achieve leverage ratios tighter than international standards; reach cooperation agreements with foreign supervisors; reform deposit insurance; increase FINMA resources.

### Key economic indicators and projections (selected exact figures)
- Real GDP (percent change): 2010 3.0; 2011 1.8; 2012 1.0; 2013 2.0; 2014 2.1; 2015 2.2.
- Consumer price index (percent change): 2010 0.7; 2011 0.2; 2012 -0.7; 2013 -0.2; 2014 0.2; 2015 0.5.
- Unemployment rate (percent): 2010 3.5; 2011 2.8; 2012 2.9; 2013 3.2; 2014 3.2; 2015 3.0.
- Nominal GDP (billions of Swiss francs): 2010 572.7; 2011 585.1; 2012 591.9; 2013 603.2; 2014 621.7; 2015 641.3.
- SNB total assets (millions of SFr): 2010 269,955; 2011 346,079; 2012 499,434; 2013 490,382.
- Foreign currency reserves (millions of SFr): 2010 203,810; 2011 257,504; 2012 432,209; 2013 443,275.
- Mortgage debt: above 140 percent of GDP at end-2013.
- Counter Cyclical Capital Buffer (CCB): activated to "1 percent CET1 capital by end–September, 2013" and raised to 2 percent in January 2014 (to be fulfilled by end-June, 2014).
- Current account (percent of GDP): 2010 14.8; 2011 9.0; 2012 9.6; 2013 9.6; 2014 9.9; 2015 9.8.
- Net IIP (percent of GDP): 2010 115.6; 2011 141.4; 2012 139.3; 2013 143.3; 2014 148.3; 2015 153.4.
- Regulatory capital as percent of risk-weighted assets: 2007 12.1*; 2008 14.7*; 2009 17.9; 2010 17.3; 2011 16.7; 2012 16.9; 2013 16.4.
- Broad money (M3) growth (percent change): 2010 6.4; 2011 6.9; 2012 8.0; 2013 9.7.

### Selected Key Recommendations (preserving phrasing and timing)
- "The floor should remain in place for now to guard against deflationary risks."
- Consider negative interest rates on banks’ excess reserves in case of renewed strong pressures on the franc. — Short term / contingent
- Strengthen provisioning on SNB balance sheet; prioritize provisioning over transfers to distribution reserve. — Short term
- Remain alert to build-up of risks in domestic real estate and mortgage markets; fully enforce self-regulation; consider further raising the CCB and introducing additional tools (e.g., DTI and LTV limits). — Short term
- Impose a leverage ratio tougher than international minima on the banks. — Short term
- Reach agreement with partner supervisors on resolution of the country’s G-SIFIs and make largest banks resolvable without government support. — Medium term
- Overhaul deposit insurance: transparency, faster payouts, ex ante financing, fund powers for least-cost actions. — Short term
- Increase FINMA resources and refine use of external auditors; rotate audit firms periodically and finance audits via a FINMA-administered fund. — Short to Medium term

*Italic: IMF staff report excerpt and related Executive Board and Swiss authorities statements (April 30, 2014) contained in the provided content unit.*

### 1. Measures to Address Developments in the Housing and Mortgage Market  __________________ 11

### 1. Measures to Address Developments in the Housing and Mortgage Market

### Context
- The Swiss economy has regained momentum, but monetary and exchange rate conditions have not normalized.
- No foreign exchange market intervention has taken place since 2012, yet the currency has remained close to the floor imposed by the Swiss National Bank (SNB) in 2011.
- Policy rate at zero and abundant excess liquidity have contributed to continued imbalances in the mortgage market, though at a somewhat slower pace than last year.
- Structural challenges and medium-term pressures:
  - Erosion of bank secrecy challenges Switzerland’s role as a center for global wealth management.
  - Under international pressure, parts of the corporate taxation system that favor income from foreign operations need reform.
  - A popular vote approved curbs on immigration, endangering the free movement of labor agreement and potentially broader cooperation with the EU; lower immigration would accelerate population aging.
- Large financial sector: size and global reach are substantial; the 2014 FSAP Update notes marked improvement since the Global Financial Crisis and recommends additional regulatory, oversight, and safety net measures.

### Recent Economic Developments and Outlook — A. GDP Growth Has Accelerated and Inflation Is Still Close to Zero
- 2013 GDP growth: 2.0 percent (up from 1 percent in 2012).
- Drivers in 2013:
  - Private consumption supported by wage increases and negative inflation raising real disposable income.
  - Construction rebound.
  - Improving external sector contribution to growth.
- Unemployment rate: 3.2 percent (rise due to 2012 slowdown but still low internationally).
- Labor supply boosted by net immigration of some 1 percent of the population (highest since 2008).
- Price developments:
  - After two years of deflation, price growth is hovering around zero.
  - Negative inflation from foreign goods and services offset by positive inflation from domestic goods and services.
  - Inflation expectations (consensus forecasts) have come down somewhat but remain well anchored in positive territory.
- Exchange rate and SNB balance sheet:
  - Franc traded in a 1.22–1.25 band relative to the euro during July 2012–April 2013; somewhat above the 1.2 floor.
  - CHF/EUR appreciation since April 2013 with episodes of global financial volatility bringing franc closer to the floor.
  - SNB balance sheet remained elevated at around 80 percent of GDP.

### Recent Economic Developments and Outlook — B. Pressures in the Housing Market Are Proving Difficult to Contain
- Banking sector trends:
  - Large banks’ balance sheets continue to shrink as they adjust to new regulatory requirements.
  - Domestically-oriented banks have grown substantially, fueled by increases in real estate lending and rising exposure to potential sharp price corrections and higher interest rates.
  - Overall banking sector: well capitalized and profitable.
- Real estate and mortgage indicators:
  - Residential real estate prices have grown faster than income; prices of owner occupied apartments rising at 6 percent per year on average since 2008.
  - Real residential prices now above early 1990s peak.
  - Mortgage debt: brought above 140 percent of GDP at end-2013 (historic peak).
  - Average mortgage maturity: about 5 years, with frequent rollovers at maturity, exposing households to future interest rate hikes.
  - Mortgage growth in the buy-to-let sector is a source of concern.
  - Non-mortgage lending to corporations remained subdued; default rates and credit ratings stable.

### Recent Economic Developments and Outlook — C. The Fiscal Deficit and Debt Are Low
- Fiscal position:
  - General government budget was close to balance in 2013; small deficits at federal and cantonal level offset by surplus in social security funds.
  - Federal balance deteriorated somewhat relative to 2012 due to higher subsidies, grants, and social benefits.
  - Reforms to unemployment insurance and a VAT increase earmarked for invalidity pensions kept social security funds in surplus.
- 2014 fiscal stance: expected broadly neutral; general government should record a small deficit reflecting lack of an SNB profit distribution and one-off restructuring contributions to cantonal pension funds.
- Cantonal pressures: need to raise funding ratio of cantonal pension funds and changes in hospital financing; corporate tax reform envisaged to enter into force as of 2018 likely to lead to revenue loss for cantons.
- Federal response: plan to restrain spending and implement a consolidation package as part of burden sharing with cantons.
- Structural balance: should remain close to zero beyond 2014, with deficits at cantons and communes offset by surpluses in federal government and social security funds.
- Debt dynamics: debt-to-GDP ratio should fall to 44 percent of GDP in 2017 (on a GFSM-basis).
- Medium-term spending pressure from population aging: peak at about 4 percent of GDP by 2055.

### Outlook and Risks
- Baseline growth projections:
  - 2014 growth: 2.1 percent.
  - 2015 growth: 2.2 percent.
  - Inflation: expected to rise gradually and the output gap to progressively close.
- Upside risk: strengthening global recovery would raise external demand with positive spillovers.
- Key downside risks:
  - Disorderly exit from unconventional monetary policy in major advanced economies causing surges in global volatility and renewed safe haven inflows, potentially forcing SNB intervention.
  - Protracted EM turmoil rekindling attractiveness of Switzerland as a safe haven.
  - Re-emergence of euro area financial stress from policy slippages or adverse shocks.
- Domestic risk: mortgage market imbalances building since 2007 though at a slower pace than typical housing bubble episodes; domestically-oriented banks especially vulnerable due to high, undiversified mortgage exposure.
- FSAP stress tests:
  - Domestically-oriented banks found well capitalized under all scenarios, including a housing crash scenario, though analysis limited by lack of supervisory data on individual banks.
  - Two large banks: remain highly leveraged and interconnected; stress tests show they comfortably exceed capital requirements under all adverse scenarios when applying the phase-in of Basel III rules, but under the most severe macroeconomic scenario capital ratios could fall below the 7 percent threshold under a fully implemented Basel III capital definition.
  - Outward spillover contribution of Swiss large banks to vulnerability of other global banks has decreased significantly.
  - Almost all banks satisfy the LCR requirement, helped by unusually high deposits at the central bank.
- Contingent fiscal liabilities: stress tests suggest existing capital buffers in the banking sector should be sufficient to absorb losses from severe macroeconomic shocks, implying limited fiscal contingent liabilities.
- Financial-sovereign spillovers: contagion from banks to sovereign seems contained at present due to stronger capital buffers, fading euro-zone tail risk concerns, and lower investor risk aversion.
- Cantonal bank considerations: some have explicit funding guarantees and are large relative to cantonal economies.

### The Authorities’ View
- Authorities more sanguine than staff on the baseline scenario but agreed on main risk factors.
- Growth forecasts aligned for 2014; authorities envisaged a stronger acceleration in 2015.
- Authorities agreed with staff that growth prospects are subject to considerable uncertainty due to euro area and emerging market developments and exit from unconventional monetary policies in major advanced economies.

### Policy Discussions — A. External Sector Assessment
- 2013 current account:
  - Preliminary estimates indicate a surplus of 13 percent of GDP, a 3.4 percent of GDP increase over 2012.
  - Staff estimates a current account surplus of around 9½ percent of GDP for 2013 to reflect likely downward revisions.
- Drivers of current account changes:
  - Goods balance improved slightly; services exports softened (including merchanting receipts).
  - Bulk of current account increase accounted for by net investment income, highly volatile and subject to large downward revisions (averaging 5 percent of GDP over the last two years).
- Factors that may overstate the surplus:
  - Merchant services by international commodity trading companies contribute around 3 percent of GDP to the current account surplus in recent years, though some companies have limited activities in Switzerland.
  - Multinationals partly owned by foreigners via portfolio shares: retained earnings should be partly attributed to foreign shareholders.
  - Cross-border shopping and mail/courier deliveries from abroad may not be fully reflected in imports.
  - Profit shifting and booking of profits in low-tax financial centers may inflate net exports; quantification not possible at present.
- Staff assessment: current account broadly in line with fundamentals given high per capita income, financial center structure, and demographics; surplus somewhat larger than the norm but explainable by identified anomalies.
- Real exchange rate:
  - Franc estimated 7 percent overvalued according to the External Balance Assessment methodology, broadly unchanged since last year.
  - REER-ULC appreciated by 2.6 percent since end-2012, and cumulatively by 1.3 percent since end-September 2011.
  - With negative inflation differentials disappearing and nominal exchange rate appreciating with the euro over the last 12 months, the over-valuation is no longer correcting itself.
  - If safe haven flows reverse, the real exchange rate overvaluation should reverse.
- Authorities’ perspective:
  - Broad concurrence with staff on the current account and real exchange rate assessment.
  - Noted substantial difficulty in interpreting current account movements due to its special structure and anomalies, and anticipated substantial statistical changes with adoption of BPM6 in June 2014.
  - Authorities stressed that depending on methodology, the franc’s overvaluation—seen as burdensome for export-oriented manufacturing—may be larger than the 7 percent IMF assessment.

### Policy Discussions — B. Monetary and Exchange Rate Policies
- Macroeconomic policy stance:
  - Domestic macroeconomic conditions do not call for monetary tightening yet; risk of resumption in safe haven inflows remains considerable.
  - Both core and headline inflation turned slightly positive at end-2013, but international inflation declines, particularly in the euro area, exert downward pressure on prices.
  - Strongly open labor market means stronger domestic activity may not generate wage and price pressures (though future immigration curbs may change this in the medium term).
  - Money multiplier remains very low.
- Risks without the floor:
  - Without the floor, renewed safe haven pressures could translate into sharp nominal appreciation and a return of deflation.

*Source: IMF staff report — "Measures to Address Developments in the Housing and Mortgage Market" (excerpts).*

### 21.      The floor should remain in place for now to guard against deflationary risks. Going

### _cr14142 - 21.      The floor should remain in place for now to guard against deflationary risks. Going

### Monetary policy stance: exchange rate floor and scenarios
- Recommendation: "The floor should remain in place for now to guard against deflationary risks."
- Policy objective: balance keeping inflation expectations well anchored against the risk of excessive tightening of monetary conditions through renewed exchange rate appreciation; requires careful calibration of unconventional policy instruments.
- Upside scenario (global recovery, euro area confidence solidifies):
  - Past safe haven flows would revert, potentially pushing the franc well above the floor.
  - Deflation concerns would be muted; "no need for a large depreciation to drive up inflation."
  - A large depreciation would be questionable from a multilateral perspective given the balanced external position.
  - Policy prescription: the SNB should gradually reduce its holdings of foreign exchange reserves, supported by clear communication to avoid market disruption and adverse outward spillovers.
  - If inflation threatens to move above comfortable levels as recovery takes hold, the SNB should raise the policy rate, "even if the balance sheet has not returned to its pre-crisis level."
- Downside scenario (disorderly exit from UMP, euro-area downside risks, EM sell-off crisis):
  - Safe haven inflows may return; a premature exit from the floor would likely result in a sharp appreciation and renewed deflationary pressures.
  - Policy prescription: the SNB should keep the floor in place and consider imposing a negative interest rate on bank excess reserves to discourage inflows.
- Domestic adverse shocks:
  - Negative interest rates might help address deflationary pressures arising from adverse domestic shocks.
  - The impact of negative rates would need careful monitoring; macroprudential measures may need reinforcement to prevent exacerbation of mortgage market imbalances.

### SNB balance sheet and provisioning
- Risk concern: "Risks from the large SNB balance sheet need to be mitigated."
- Recent event: SNB announced a sizable valuation loss on gold holdings, triggering the first suspension of profit transfers to the Confederation and cantons in recent memory.
- Historical note: build-up of risk provision was stepped up in 2011, but "it has not kept pace with the increase in the balance sheet."
- Recommendation: "Going forward, provisioning should receive priority over transfers to the distribution reserve."
- Authorities’ view:
  - SNB continues to see the exchange rate floor as essential to guarding against risk of deflation.
  - SNB attributed multiple downward revisions to its inflation forecast to weaker euro area inflation and a very protracted pass-through from past appreciation.
  - SNB agreed negative interest rates on banks’ excess reserves were a possible tool if safe haven inflows resumed on a significant scale.
  - On balance sheet management and risks, the SNB viewed current profit distribution arrangements as sufficiently protective of its capital.

### Housing market: developments and policy measures
- Finding: "Despite measures taken by the authorities, risks in the mortgage and housing markets continue to build."
- Policy actions in 2012–2013: tightened lending requirements and increased banks’ capital buffers for mortgage risk; effects appear small so far.
- House price growth: prices for owner occupied apartments had grown "by about 6 percent per year on average since 2008," and grew at "4.3 percent (year-on-year) in the second half of 2013."
- Lending and standards: limited cooling in mortgage lending growth; mortgages to buy-to-let companies accelerated in 2012–13; quantitative lending standards show no or limited reduction in DTIs or LTVs.
- Data gap: distribution of wealth and mortgage debt across households not available; concern that vulnerable households may be taking on excessive debt.

Box 1 — Measures to Address Developments in the Housing and Mortgage Market
- New minimum requirements drawn up by the Swiss Bankers Association recognized by FINMA, effective mid-2012:
  - Down payment of 10 percent of the lending value of the property from the borrower's own funds, which may not be obtained by pledging or early withdrawal of Pillar 2 pension assets;
  - Mortgages must be paid down to two thirds of the collateral value within a maximum of 20 years.
- FINMA tightened rules for risk-weighting new and renewed mortgages for banks applying an internal ratings-based approach, effective 2013.
- Federal Council measures, effective 2013:
  - Mortgages that do not comply with the new minimum standards are allowed, but subject to a risk weight of 100 percent;
  - Mortgages exceeding 80 percent of the property value will have a risk weight of 100 percent applied to the part of the loan exceeding the 80 percent threshold.
- Counter Cyclical Capital Buffer (CCB) activation (on SNB’s proposal):
  - CCB applies to risk-weighted positions associated to residential property mortgages in Switzerland.
  - CCB was activated to a level of "1 percent CET1 capital by end–September, 2013 and raised to 2 percent in January 2014 (to be fulfilled by end-June, 2014)."

### Housing market policy assessment and recommendations
- Assessment: measures taken are welcome but "have been only partially successful."
- View on CCB: recent hike was appropriate, but impact may not be sufficient given comfortable capitalization relative to prudential requirements in domestically oriented banking sector.
- Self-regulation: existing self-regulation measures have not been very effective; quantitative lending surveys show no or limited reduction in DTIs or LTVs.
- Recommendations:
  - Consider direct regulatory measures targeting affordability and loan-to-value ratios.
  - Stronger measures targeting mortgage demand are needed in an environment of very low interest rates.
  - If industry self-regulation (faster amortization and larger cash down payments) cannot be achieved, introduce direct regulation on maximum DTIs and LTVs.
  - Put in place parallel measures to curb mortgages to income-producing real estate companies.
  - Supervisors should continue to use Pillar II measures proactively to address concentration and interest rate risks.
  - Reduce or eliminate tax deductibility of mortgage interest.
- Authorities’ view:
  - Authorities agree imbalances have continued to expand but consider measures taken had some calming effects.
  - Decision to increase the CCB was informed by continued concerns.
  - Measures on affordability were under discussion, including with respect to the buy-to-let segment.
  - If appropriately tight measures could not be implemented through self-regulation, direct regulation was an option.
  - Political support for reform of the taxation of mortgage interest was seen as elusive.

### Financial stability, TBTF banks, and oversight
- TBTF banks: two large banks strengthening capitalization and restructuring business models; leverage ratios remain low compared to other large global banks.
- 2012 actions: both banks stepped up plans to build high-quality capital and initiated strategic restructuring toward less capital-intensive wealth management.
- End-2013 status:
  - Both banks were already above the "10 percent minimum CET1 capital ratio in the Swiss Too-Big-Too-Fail (TBTF) legislation to be met by 2019."
  - Leverage ratio progress slower; both banks are below the fully-implemented Swiss minimum leverage ratio and lag behind most other large global banks based on other leverage measures.
  - Liquidity position is strong, with Basel III Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) exceeded at end-2013.
  - Both banks were profitable in 2013 but faced potential costs from legal risks (mortgage mis-selling, aiding tax evasion in the United States, illegal trading activity in LIBOR and foreign exchange markets).
- Recommendations for TBTF banks and resolution:
  - Rapidly bring leverage ratio in line with that of other major international banks.
  - Ensure minimum requirements in terms of leverage are more ambitious than minimum international standards in both level and quality of capital.
  - Note: the current Swiss total capital leverage ratio minimum is above the envisaged 3 percent Basel, but a substantial portion can be held as CoCos, which are not necessarily Tier 1 capital.
  - FINMA’s ongoing examination of differences between internal model risk-weights and standard approach is welcome; model approval decisions should be reviewed where differences are large.
  - Commendation for FINMA demanding higher risk weighted assets for operational risk from the two large banks.
  - Priority: make TBTF resolution regime robust and workable cross-border; finalize a viable strategy to make largest banks resolvable without government support; reaching a cooperation agreement with the U.S. and U.K. authorities is important.
- Authorities’ view:
  - Authorities emphasized capital regulation will remain tighter than international standards.
  - Switzerland already has a minimum leverage ratio in place; as Basel III leverage definition is finalized, Switzerland will ensure tougher rules than international minimums are met.
  - Authorities confirmed active work with U.K. and U.S. authorities on cross-border resolution under the "single point of entry" principle, with negotiations for a binding cooperation agreement planned to commence later this year.

### Banking supervision and deposit insurance
- Supervision:
  - Need to further strengthen banking supervision, particularly of domestic banks, including by shoring up resources.
  - FSAP Update: high level of compliance with Basel Core Principles and significant improvements, but FINMA operates with resources well below those of other supervisors.
  - Recommendations: FINMA should provide more guidance to external auditors, ensure greater harmonization across supervised entities, complement auditors’ work with more "deep dives" on selected issues.
  - Audit firms should be periodically rotated (at least every five years) and not be paid by supervised entities but rather from a FINMA-administered fund.
  - Increased resources for FINMA needed to intensify supervision of smaller and medium-sized domestically focused banks, given risks from large exposures to the domestic mortgage market.
- Deposit insurance:
  - "The Swiss deposit insurance system needs substantial reform."
  - FSAP Update identified weaknesses and proposed improvements to align with emerging international best practices, including:
    - Greater transparency to depositors on coverage conditions;
    - Commitment to faster payouts;
    - Ex ante financing in a dedicated fund;
    - Fund to have powers to take action other than bank closure when there is a cheaper alternative.
- Authorities’ view:
  - Authorities believe supervision is adequately funded and executed, and saw prospects for deposit insurance reform as limited.
  - FINMA noted the risk-based approach with experienced staff had been successful.
  - Agreement that domestically oriented banks deserve close attention; Pillar II measures had been taken on an individual banks basis.
  - On deposit insurance, authorities agreed aspects could be improved but pointed to a recent reform effort that failed to muster sufficient political consensus.

### Medium-term prospects: immigration, aging, tax and secrecy reforms
- Immigration referendum:
  - Popular vote approved re-establishment of quotas on immigration despite government and many business organizations opposing.
  - Federal Council has three years to put in place a quota regime.
  - Free movement of labor had contributed to acceleration in Swiss economic growth in the 2000s; immigrants account for a large share of the work force in many sectors.
  - Uncertainty over ability to recruit personnel may discourage new investment; additional uncertainty may arise for other cooperation agreements with the EU.
  - Positive side: reduced immigration should take some pressure off the housing market.
- Population aging and pension reform:
  - Government unveiled pension reform proposal "Pension 2020" to ensure sustainable financing of Pillar I and Pillar II while maintaining current benefit levels.
  - Main measures:
    - Harmonize reference retirement age for men and women at 65;
    - Facilitate a flexible transition to retirement from age 62 and cut benefits for early retirement;
    - Introduce a sustainability rule for social security funds requiring reversible automatic increases in contributions or cuts in benefit indexation if funding ratio falls below 70 percent and deficits exceed 3 percent for two consecutive years.
  - For Pillar II pensions: reduce the minimum conversion rate from "6.8 percent to 6 percent" and redefine the minimum interest rate at the end of each year when achieved investment performance is known.
  - Financing: "A two percentage point increase in the VAT and higher social security contributions would finance the cost."
  - Staff view: aligning male and female retirement age is appropriate; placing social security funds under a fiscal rule should reduce fiscal risks.
- Corporate tax and bank secrecy:
  - Corporate income tax treatment on foreign activities under international scrutiny; authorities developing strategy to reform special tax regimes that give more favorable tax treatment to income from foreign operations, envisaged to enter into force "as of 2018."
  - Staff recommendation: design new regime taking into account international efforts to counter base erosion and profit shifting.
  - International initiatives on tax evasion and money laundering are eroding bank secrecy; potential challenges to parts of Swiss wealth management business.
  - Staff stressed need to closely monitor wealth management during likely downsizing to avoid risks to financial stability.
  - Recommendation: forcefully implement FATF and Global Forum standards, particularly criminalization of tax crimes as predicate offences to money laundering, transparency of legal persons, and due diligence for politically exposed persons.
- Authorities’ view:
  - Considered it early to assess effects of immigration referendum but optimistic about pension reform.
  - Agreed uncertainty over final outcome not helpful to growth; Federal Council moving speedily to develop strategies.
  - On pension reform, importance of reforming Pillar I and II together; parliamentary process likely protracted, with enactment expected by 2020.
  - On corporate tax reform, goal to maintain international competitiveness; buffers being built in the federal budget for possible burden sharing of revenue losses with cantons.
  - On wealth management, authorities do not expect large adverse effects as competing financial centers will also adopt new standards.
  - Progress reported on implementing AML-CFT standards; draft bill for implementing revised 2012 FATF Recommendations approved by upper house and to be taken up by lower house later this year. An FATF Evaluation will start in the fall of 2014 and be finalized in 2016.

*International Monetary Fund staff summary of policy findings and recommendations from the cited chapter.*

### 40.      The exchange rate floor continues to be a necessary element of the monetary policy

### _cr14142 - 40.      The exchange rate floor continues to be a necessary element of the monetary policy

### Monetary policy and exchange rate stance
- The exchange rate floor continues to be a necessary element of the monetary policy framework.
- Inflation is still "close to the bottom of the range compatible with the SNB definition of price stability."
- Renewed exchange rate appreciation, as might arise from a new bout of safe haven inflows, "would quickly bring back deflationary pressures."
- Monetary conditions need to remain expansionary and "the exchange rate floor needs to remain in place."
- "Negative interest rates on banks’ excess reserves may need to be introduced in case of renewed strong pressures on the franc."
- The SNB balance sheet is likely to remain extended for a prolonged period with large fluctuations in mark-to-market profits, and "provisions need to be strengthened to bring capital in line with risks."
- Recommendation: Next Article IV consultation "take place on the standard 12-month cycle."

### Macroprudential policy, housing, and mortgages
- Stronger policies to curb the demand for mortgages are needed to reduce the risk of a sharp adjustment down the road.
- The recent hike in the CCB is welcome, "but its impact may not be sufficient as capital is not a constraint across the domestically oriented banking sector."
- More aggressive policies to discourage vulnerable households from taking on too much mortgage debt should be implemented, including:
  - Tighten existing self-regulation measures (e.g., "to speed up loan amortization").
  - Parallel measures to curb mortgage growth in the buy-to-let segment.
  - If self-regulation proves limited, consider stricter direct regulation, including "mandatory affordability caps and maximum loan-to value ratios."
  - Phase out tax incentives that encourage borrowing to finance home buying.

### Immigration, labor force, and pensions
- The recent referendum to move away from the free movement of labor with the EU "has increased uncertainty about medium-term economic prospects."
- Since the free movement accord with the EU came into force, immigration "has increased the labor force by about one percentage point per year."
- Immigrants "account for a large share of the work force in many important sectors." Uncertainty about future ability to recruit needed personnel may discourage new investment.
- Additional uncertainty may arise if some key cooperation agreements with the EU "could be called into question."
- Slower immigration will increase the challenges of an aging population.
- The new legislative pension reform proposal aims "at placing first and second pillar pensions on a sustainable financial basis in light of population aging."
  - "Aligning the retirement age of women with that of men is appropriate."
  - Placing the social security funds under a fiscal rule "should reduce fiscal risks going forward."

### Tax and fiscal policy
- Plans to reform the corporate income tax to make it internationally acceptable are welcome.
  - Authorities are seeking to "eliminate the favorable tax treatment on income from foreign activities granted to corporations by cantons."
  - Authorities are encouraged to put in place a new regime taking into account international efforts to counter base erosion and profit shifting.
  - Strategy to build buffers in the federal budget for possible burden sharing of fiscal costs with the cantons should facilitate this reform.

### Financial sector resilience and regulatory reform
- Continuing the financial sector reform agenda will strengthen soundness and resilience; the Swiss banking and insurance sectors play a prominent global role.
- In line with the FSAP update recommendations, authorities are encouraged to:
  - Press the large banks to continue efforts to rapidly bring their leverage ratios into line with those of other major international banks, ensure "an ambitious minimum leverage ratio requirement," and improve transparency as regards risk weights.
  - Continue discussions with international counterparts to reach agreement on measures to make the large banks resolvable without public sector support.
  - Increase resources available to FINMA for banking supervision, to extend intensive supervision beyond the largest banks.
  - Refine FINMA’s use of external auditors for onsite supervision, including through periodic rotation of auditing firms, ensuring auditors are paid from a FINMA-managed bank-financed fund, and providing more guidance on their supervisory focus.
  - Overhaul the deposit insurance scheme to bring it into line with emerging international best practices, including:
    - Greater transparency to depositors on coverage conditions.
    - Commitment to faster payouts.
    - Ex ante financing in a dedicated fund.
    - The fund to have powers to take action other than bank closure when there is a cheaper alternative.

### Key FSAP recommendations (selected, with timing preserved)
- Impose a leverage ratio on the banks that is tougher than international minima. — Short term
- Remain alert to the build-up of risks in domestic real estate and mortgage markets. Fully enforce self-regulation, and consider further raising the CCB and introducing additional tools (e.g., debt-to-income (DTI) and loan-to-value (LTV) limits). — Short term
- Reach agreement with partner supervisors as to the resolution of the country’s G-SIFIs. — Medium term
- Make available the full range of best practice resolution powers to handle any bank deemed systemic at the time. — Medium term
- Overhaul the deposit insurance scheme: make its provisions more transparent; reform its governance; and build up dedicated ex ante funding with a back-up line of support. Make deposit insurance funds available to finance resolution measures on a least-cost basis. — Short term
- Monitor closely the condition of the life insurance firms in advance of the prospective elimination of the palliative measures protecting the companies from the effects of low interest rates, and enhance public understanding of the SST. — Medium term
- Issue guidance on the cantonal banks’ governance, based on their best practice, including reducing political interconnectedness. Issue guidance on guarantees for cantonal banks, to enhance transparency and create a level playing field both across the cantonal banks and with the rest of the banking sector. — Short term
- Ensure that the likely consolidation among the private banks in response to U.S. tax pressures proceeds smoothly. — Short term
- Issue guidance to auditors to ensure consistency of supervision, and undertake more “deep dives” into particular areas of concern. Increase the intensity of onsite supervision, including of middle-sized and smaller banks. — Short term
- Increase FINMA’s resources so it can carry out its agenda for supervisory enhancement. The resource pool for highly qualified staff could be expanded. — Short to Medium term
- Prioritize regulatory reform of securities markets, to bring arrangements up to international standards. Enhance focus on conduct of business supervision of banks and securities dealers. — Medium term
- Pursue legislation to improve policyholder protection, enhance brokers’ supervision, and increase the level of public disclosure. — Medium term
- Bring FMIs into compliance with new international principles and establish crisis management arrangements between the authorities of FMIs. — Short term
- Establish transparency in the financial sector as a core element of the Swiss “brand,” in particular through heightening banks’ disclosure requirements, including as regards capital weighting and providing data for adequate risk analysis. — Short term

### Authorities’ response to past IMF policy recommendations (selected)
- Monetary and Exchange Rate Policy I: "The exchange rate floor should remain in place for now." — Implemented.
- Monetary and Exchange Rate Policy II: "Introduce negative interest rates on excess bank reserves in case of renewed appreciation pressures." — The authorities view negative interest rates as a possible policy tool to defend the floor.
- Monetary and Exchange Rate Policy III: "More rapid growth in the SNB capital" — The authorities consider the current approach sufficient.
- Financial Sector Policy I: Forceful monitoring and enforcement of the new minimum regulatory standards and a proactive use of supervisory discretion, stand ready to implement new measures or tighten existing ones, including raising the CCB to the maximum of

*SWITZERLAND — INTERNATIONAL MONETARY FUND*

### 2.5 percent or introducing minimum affordability

### 2.5 percent or introducing minimum affordability

### Financial sector policies and housing affordability
- Authorities have implemented self-regulation on mortgage lending but "believe that further tightening is needed and are discussing such measures."
- Countercyclical capital buffer (CCB) was increased from 1.0 to 2.0 percent, to be fulfilled by end-June 2014.
- Policy actions listed:
  - Financial Sector Policy II: Phase out existing tax incentives for mortgage debt — No action taken.
  - Financial Sector Policy III: More rapid progress on the leverage front — "The two big banks have made significant progress, but more is needed."
  - Financial Sector Policy IV: Make further progress on cross-border bank resolvability — "Progress is ongoing."
- Housing and mortgage indicators and concerns:
  - "M3 growth" elevated (charted through 2014) and "high rates of M3 growth are beginning to moderate..."
  - "Total Mortgage Claims (percent of GDP)" shown at record-high levels (charted by year).
  - Figure evidence: nominal and real house prices, price-to-income and price-to-rent ratios for Switzerland relative to past episodes and OECD average (indices with peak-normalization).

### Macro outlook and real economy
- Growth and labor:
  - "The economy has recovered in 2013 and the growth outlook is stable with growth around 2 percent (but almost 1 percent is population growth)."
  - Employment and consumption "have continued to rise" (charts of real private consumption and employment).
  - Real GDP (percent change) historical and projections: 2010 3.0, 2011 1.8, 2012 1.0, 2013 2.0, 2014 2.1, 2015 2.2 (Table 1).
  - Private consumption: 2010 1.7, 2011 1.1, 2012 2.4, 2013 2.3, 2014 1.8, 2015 1.8 (Table 1).
  - Unemployment rate (in percent): 2010 3.5, 2011 2.8, 2012 2.9, 2013 3.2, 2014 3.2, 2015 3.0 (Table 1).
- Prices:
  - Consumer price index (percent change): 2010 0.7, 2011 0.2, 2012 -0.7, 2013 -0.2, 2014 0.2, 2015 0.5 (Table 1).
  - "Deflationary pressures are abating." (figure annotation).
- Fiscal:
  - "The fiscal position remains strong with persistent surpluses and a declining debt level." (figure annotation).
  - General government balance (percent of GDP) shown with persistent surpluses historically; Table 1 shows Balance: 2010 0.1, 2011 0.3, 2012 0.0, 2013 0.0, 2014 -0.2, 2015 0.4.
  - Nominal GDP (billions of Swiss francs): 2010 572.7, 2011 585.1, 2012 591.9, 2013 603.2, 2014 621.7, 2015 641.3 (Table 1).

### Monetary policy, exchange rate, and SNB balance sheet
- Monetary stance:
  - SNB repo rate (1 week) and 3-month Libor charted; "Near-zero policy rates have kept monetary policy accommodative..."
  - Exchange-rate floor: "Floor on 09/06/11" and "helped keep the Swiss franc stable relative to the euro."
- SNB balance sheet and reserves:
  - SNB total assets (millions of SFr): 2010 269,955; 2011 346,079; 2012 499,434; 2013 490,382 (Table 4).
  - Foreign currency reserves (millions of SFr): 2010 203,810; 2011 257,504; 2012 432,209; 2013 443,275 (Table 4).
  - Gold holdings (millions of SFr): 2010 43,988; 2011 49,380; 2012 50,772; 2013 35,565 (Table 4).
  - Memorandum items: Balance sheet, percent of GDP: 2010 47.1, 2011 59.1, 2012 84.4, 2013 81.3 (Table 4).
  - "Past foreign exchange interventions still sit on the greatly-expanded SNB balance sheet." (figure annotation).
- Liquidity and credit:
  - Broad money (M3) growth (percent change, averages) shown: 2010 6.4, 2011 6.9, 2012 8.0, 2013 9.7 (Table 1).

### External account and capital flows
- Current account and composition:
  - Current account (percent of GDP, Table 2): 2010 14.8, 2011 9.0, 2012 9.6, 2013 9.6, 2014 9.9, 2015 9.8.
  - Net investment income (billions SFr, Table 2): 2010 -26, 2011 23, 2012 50, 2013 22, 2014 30, 2015 29.
  - "The preliminary current account estimates for 2013 imply a sharp increase over 2012... but mainly high net investment income, which tends to be volatile and subject to very large revisions."
- Balance of payments:
  - Official reserves (billions of U.S. dollars, end-period, Table 2): 2008 68.8, 2009 135.9, 2010 260.0, 2011 334.2, 2012 526.1, 2013 533.9 (Table 2).
  - Reserve cover (months of imports of GNFS): 2008 3.9, 2009 7.7, 2010 12.9, 2011 15.6, 2012 23.5, 2013 23.4 (Table 2).
- International investment position (IIP):
  - Net IIP (percent of GDP, Table 2) increases: 2010 115.6, 2011 141.4, 2012 139.3, 2013 143.3, 2014 148.3, 2015 153.4.

### Risk Assessment Matrix — main threats and likelihoods
- Side-effects from global financial conditions (UMP exit) — Likelihood: High. Expected impact: Medium. Notes: "Bouts of market volatility and higher-than-expected increases in long-term rates could occur... Disorderly unwinding of UMP might cause renewed safe haven inflows into Switzerland... Pressures on the housing market may also intensify."
- Protracted period of slower growth in advanced and emerging economies — Likelihood: High for Europe, Medium elsewhere. Expected impact: Low. Notes: "Europe is the main trading partner of Switzerland, a protracted period of slower European growth would dampen economic growth and possibly cause a recession."
- Financial stress in the euro area re-emerges — Likelihood: Medium. Expected impact: Medium. Notes: "Safe haven capital inflows would resume, requiring intervention. Pressures on the housing market may also intensify."
- Sharp correction in the housing market — Likelihood: Medium. Expected impact: Medium. Notes: "A sharp correction in housing prices would weaken household balance sheets and slow down growth... Domestically-focused banks are particularly vulnerable, though they are well capitalized on average."
- Bond market stress from a reassessment in sovereign risk — Likelihood: Medium. Expected impact: Low. Notes: "Global asset managers may maintain or further shift asset allocations to safe havens, including Swiss-franc denominated assets... Safe haven flows would put the currency under pressure again..."
- Risks from incomplete regulatory reforms (delays, dilution, inconsistent approaches) — Likelihood: Medium. Expected impact: Medium. Notes: "The banking sector is highly globally interconnected, and large banks are highly leveraged and have large wholesale funding positions."
- Increasing geopolitical tensions surrounding Ukraine — Likelihood: Medium. Expected impact: Medium. Notes: "The direct impact should be limited. However, contagion and heightened volatility in financial markets may trigger renewed safe haven flows."

### Banking sector soundness and systemic indicators
- Systemic bank indicators (Figure 5 and Table 5 highlights):
  - Tangible Common Equity to Tangible Assets (Percent) charted for large Swiss banks and peers.
  - Loans-to-deposits and Liquid assets-to-deposits (Percent) charted; wholesale funding shown as percent of total funding.
  - Regulatory capital as percent of risk-weighted assets (Table 5): 2007 12.1*, 2008 14.7*, 2009 17.9, 2010 17.3, 2011 16.7, 2012 16.9, 2013 16.4 (Table 5; note * caveat regarding Basle I/II calculation).
  - Net long position in foreign exchange as a percentage of tier I capital: 2007 13.7*, 2008 -16.1*, 2009 -23.2, 2010 -41.1, 2011 -61.2, 2012 -47.6, 2013 -55.9 (Table 5).
  - Sectoral distribution of bank credit to the private sector: Households 2007 71.5, 2008 65.4, 2009 67.1, 2010 68.3, 2011 68.8, 2012 65.6, 2013 65.7 (Table 5).
  - Non-performing loans as percent of gross loans: 2007 0.3, 2008 0.9, 2009 1.0, 2010 0.9, 2011 0.8, 2012 0.7, 2013 ** (Table 5; ** not yet available).

### Debt dynamics and fiscal sustainability (DSA)
- Federal Government DSA baseline highlights (Table 7 and Table 8):
  - Nominal gross public debt (percent of GDP): 2012 31.2, 2013 25.4, 2014 24.9, 2015 24.2, 2016 23.3, 2017 22.4, 2018 21.4, 2019 20.5.
  - Public gross financing needs (percent of GDP): 2012 3.3, 2013 3.2, 2014 3.4, 2015 3.0, 2016 0.7, 2017 1.3, 2018 0.5, 2019 0.6 (Table 7).
  - Real GDP growth (in percent) projected: 2012 2.0, 2013 1.0, 2014 2.0, 2015 2.1, 2016 2.2, 2017 2.0, 2018 2.0, 2019 1.8 (Table 7).
  - Inflation (GDP deflator, in percent) projections: 2012 1.1, 2013 0.1, 2014 0.0, 2015 0.9, 2016 0.9, 2017 0.9, 2018 0.9, 2019 1.0 (Table 7).
  - Effective interest rate (in percent) projected to rise from 2.1 in 2012 to 4.2 in 2019 (Table 7).
  - Change in gross public sector debt (cumulative projection, Table 7): cumulative -5.3 (percent of GDP) over projection period.
- Alternative scenarios and assumptions (Table 8):
  - Baseline, Historical, and Constant Primary Balance scenarios presented with underlying assumptions for Real GDP growth, Inflation, Primary Balance, and Effective interest rate for 2014–2019 (Table 8).

*Source: _cr14142 - 2.5 percent or introducing minimum affordability*

### Annex 1. Surges in Global Financial Volatility and the Swiss

### Annex 1. Surges in Global Financial Volatility and the Swiss Franc

### Safe-haven flows and market moves
- Switzerland’s attraction as a safe haven was re-affirmed during recent bouts of global financial turbulence.
- Following the May 22, 2013 Fed “taper talk,” the franc strengthened against major EM currencies, the euro, and the U.S. dollar, indicating volatility-induced safe haven inflows dominated any portfolio re-allocation away from Switzerland due to a higher yield differential vis-à-vis the United States.
- Safe haven inflows resumed in January 2014 on renewed market concerns about EM resilience and were further reinforced by the crisis in Ukraine.
- Franc appreciation dynamics since end-2013:
  - The franc has appreciated against other safe haven currencies since end-2013.
  - Switzerland received the largest global mutual fund inflows as a percent of GDP (chart: Global Mutual Fund Inflows Since end-2013, cumulative percent of projected 2014 GDP; Source: EPFR Global).

### 10-year sovereign yields (basis points) — market snapshots
- Peak Δ after May 22 taper talk:
  - CHE 29
  - Avg. 32
  - DEU 30
  - USA 49
  - JPN -2
  - GBR 50
- Δ since start of 2014:
  - CHE -30
  - Avg. -32
  - DEU -41
  - USA -33
  - JPN -10
  - GBR -44
- Level as on March 14, 2014:
  - CHE 94
  - Avg. 190
  - DEU 151
  - USA 266
  - JPN 64
  - GBR 280
- Source for yields: Haver.

### Vulnerabilities and macro implications for Switzerland
- Although inflows are small relative to 2009–12 levels, recent inflows highlight Switzerland’s particular vulnerability to major shifts in global risk sentiment.
- Potential risks from a materially stronger franc:
  - Could push down Swiss inflation, already close to zero and the lowest among peers.
  - Swiss long-term yields have again sunk below 1 percent, leaving even less space for conventional monetary accommodation to guard against deflation/recession risks.
- De facto exchange rate regime note (from related text elsewhere on the page):
  - On September 6, 2011, the SNB set a minimum exchange rate of CHF 1.20 per euro and committed to defending the limit by buying foreign currency in unlimited quantities.
  - After end-May, 2013 the franc followed an appreciating trend within a 2 percent band against the euro; the de facto exchange rate was reclassified to a crawl-like arrangement from other managed, effective May 29, 2013.

### G20MOD simulations: scenario and results under a fully flexible exchange rate
- Scenario specification:
  - Disorderly unwinding of UMP, coupled with geo-political tensions in Europe, resulting in a 100 basis point increase in the sovereign risk premia of stressed euro area economies and EMs over 2014–17.
  - Associated safe haven inflows appreciate the franc by an average of 5 percent against the euro (and in real effective terms) during 2014–15, unwinding by 2018.
  - Policy rate bound at zero.
- Key simulation outcomes (percent deviations from staff baseline; Source: Staff estimates based on the G20MOD of the IMF Research Department):
  - Real GDP (percent deviation from baseline):
    - 2014: Switzerland -0.60; Euro Area -0.13; United States -0.03
    - 2015: Switzerland -1.51; Euro Area -0.80; United States -0.16
    - 2016: Switzerland -1.60; Euro Area -1.12; United States -0.09
    - 2017: Switzerland -1.04; Euro Area -0.99; United States 0.01
    - 2018: Switzerland -0.11; Euro Area -0.64; United States 0.05
  - Headline inflation (percent point deviation from baseline):
    - 2014: Switzerland -0.48; Euro Area -0.10; United States -0.02
    - 2015: Switzerland -0.60; Euro Area -0.40; United States -0.10
    - 2016: Switzerland -0.43; Euro Area -0.52; United States -0.08
    - 2017: Switzerland -0.32; Euro Area -0.53; United States 0.00
    - 2018: Switzerland -0.05; Euro Area -0.45; United States 0.05
  - Memo: Swiss REER (percent deviation from baseline):
    - 2014: 4.96
    - 2015: 5.61
    - 2016: 3.43
    - 2017: 1.18
    - 2018: -2.25
- Interpretation:
  - Under a fully flexible exchange rate in this adverse scenario, Swiss inflation falls below zero in 2014–15 and output losses peak at 1.6 percent in 2015 (relative to staff baseline).
  - The Swiss outcomes are worse than for the euro area and the United States, which avoid deflation in the simulations.
  - These results underscore the pivotal role of the exchange rate floor in the Swiss monetary framework as a necessary buffer against another major currency appreciation–deflation–recession cycle.

*Source: IMF staff annex titled "Annex 1. Surges in Global Financial Volatility and the Swiss Franc."*

### 4.      The FSO has taken various steps in 2013 to improve core business statistics.  In

### 4.      The FSO has taken various steps in 2013 to improve core business statistics.  In

### Business statistics improvements and dissemination plans
- In November 2013, new business census results were published for the first time since 2008, based mainly on administrative data.
- The new approach led to a significant extension of the statistical universe and enabled the FSO to take into account small business units which were below the thresholds in the census in the past.
- The FSO initiated the revision of the job statistics in order to integrate the new universe in the survey.
- The FSO plans to publish results according to the 2008 version of the System of National Accounts (SNA 2008) in September 2014.
- The timeliness of dissemination of national accounts data will improve sequentially and data on the sequence of accounts should be disseminated at t+10 beginning in 2016.

### IMF Executive Board assessment — macroeconomic outlook and policy takeaways
- The growth of the Swiss economy has gathered pace, but inflation nevertheless remains close to zero.
- The recovery is expected to continue and inflation should rise gradually while the output gap will progressively close.
- The fiscal position is healthy, with a broadly neutral stance projected for 2014, and government debt is low.
- No new foreign exchange intervention to support the exchange rate floor has been undertaken recently; past safe haven inflows have not yet reversed and the SNB balance sheet remains large.
- For 2013, the SNB reported a large valuation loss on gold holdings, triggering the first suspension of profit transfers to the Confederation and cantons in recent memory.
- Expansionary monetary policy and ample liquidity have contributed to push real estate prices and mortgage debt to historic heights:
  - Prices of owner occupied apartments rising by 6 percent per year on average since 2008.
  - Mortgage lending has grown by about 5 percent per year since 2009.
  - Mortgage debt recently reached an all-time high of over 140 percent of GDP.
- Authorities have taken measures to contain risks, including raising the countercyclical capital buffer and adopting prudential measures to tighten lending standards and conditions.
- The 2014 FSAP Update finds that the position of the financial sector has improved markedly since the Global Financial Crisis, but gaps remain in the regulatory framework, prudential oversight, and safety net.

### Directors’ specific recommendations and views
- Domestic macroeconomic conditions do not call for a monetary tightening yet; the risk of a resumption of safe haven inflows remains considerable.
- The exchange rate floor remains necessary to guard against deflationary risks; when conditions permit, a return to a flexible exchange rate would be desirable.
- Directors recommended contemplating alternative measures and specifically encouraged the authorities to consider introducing negative interest rates on excess bank reserves in case of deflationary pressures resulting from appreciation, while carefully monitoring economic impact and reinforcing macroprudential measures as needed.
- In an upside scenario, authorities should gradually reduce their holdings of foreign exchange reserves.
- Directors encouraged the authorities to step up SNB’s provisions given the likely prolonged extension of the SNB balance sheet.
- On housing and mortgage risks, Directors welcomed measures taken and advised:
  - Continue to monitor price developments in the housing sector.
  - Lay groundwork for stronger policy actions to curb demand for mortgages, potentially including tax reforms and direct regulatory measures targeting affordability and loan-to-value ratios.
- On financial sector reforms and FSAP follow-up:
  - Encourage large banks to achieve leverage ratios tighter than international standards.
  - Reach cooperation agreements with key foreign supervisors to make the large banks resolvable.
  - Reform the deposit insurance system to increase transparency and universality across banks.
  - Increase resources for prudential bank supervision, provide closer oversight and guidance to auditors performing supervisory audits, and improve governance of cantonal banks.

### Swiss authorities’ statement — alignment and clarifications
- The Fund’s outlook is broadly in line with authorities’ forecasts; 2013 growth driven by domestic sectors such as construction, investment and household consumption.
- Authorities share staff’s assessment of risks, especially those associated with 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.
  - The policy rate (3M-Libor) is at the zero lower bound and inflation – negative for two years – is just returning to zero.
  - The SNB concurs that negative interest rates on bank excess reserves would be an option if necessary.
  - The SNB is prepared to buy foreign currency in unlimited quantities to enforce the minimum exchange rate and currently has no plans to unwind or limit foreign exchange reserve accumulation.
  - The SNB has stepped up provisioning to strengthen its balance sheet.
- Fiscal policy:
  - General government is expected to record a small budget surplus in 2013 (0.3 percent of GDP).
  - 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 one-off restructuring contributions towards cantonal pension funds.
  - Fiscal indicators are expected to improve considerably thereafter, with general government recording solid surpluses; general government debt should fall further to 44 percent of GDP in 2017.
- Financial sector policies and FSAP follow-up:
  - Authorities welcome staff’s positive assessment of financial system stability and progress in implementing the 2007 FSAP recommendations, Basel III adoption, too-big-to-fail measures, stricter liquidity requirements, the countercyclical capital buffer, and targeted measures on residential real estate.
  - Authorities dispute characterization of “significant weaknesses in supervision,” noting no important Swiss bank difficulties since 2008, multiple institutions left the market without affecting creditors or clients, and the deposit insurance has not dispensed funds.
  - Authorities consider FINMA resources appropriate and emphasize the contribution of external audit firms to supervision.
  - On capital requirements and leverage:
    - Switzerland has introduced a leverage ratio for large banks in addition to risk-weighted capital requirements well ahead of envisaged Basel standard and has a comprehensive TBTF regime.
    - Authorities agree the two large Swiss banks need to further improve their leverage ratios.
  - On mortgage and housing markets:
    - Measures taken in 2012 and 2013 include (i) activation of the countercyclical capital buffer focused on residential property mortgages, (ii) prudential measures 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.
    - Authorities will continue to monitor developments and reassess the need for adjustment to the CCB regularly; discussions are taking place on further measures targeting banks’ risk-taking.
  - Resolution regime and deposit insurance:
    - The Swiss TBTF-regime does not include an ex-ante funded resolution scheme by policy design; banks are required to issue contingent convertible debt as the functional equivalent of an institution-specific resolution fund.
    - Authorities are not convinced by staff’s key recommendation to make deposit insurance funds available to finance resolution measures.
  - Swiss Solvency Test (SST) for insurers:
    - Authorities note the SST was introduced in 2010 and is a fully risk-based, market consistent solvency regime.

### Key economic indicators and projections (selected exact figures from table)
- Real GDP (percent change):
  - 2010: 3.0
  - 2011: 1.8
  - 2012: 1.0
  - 2013: 2.0
  - 2014 (Projection): 2.1
  - 2015 (Projection): 2.2
- Total domestic demand (percent change):
  - 2010: 2.7
  - 2011: 1.8
  - 2012: 1.2
  - 2013: 1.8
  - 2014 (Projection): 1.7
  - 2015 (Projection): 1.6
- Final domestic demand (percent change):
  - 2010: 2.2
  - 2011: 1.9
  - 2012: 1.9
  - 2013: 2.2
  - 2014 (Projection): 2.1
  - 2015 (Projection): 1.9
- Private consumption (percent change):
  - 2010: 1.7
  - 2011: 1.1
  - 2012: 2.4
  - 2013: 2.3
  - 2014 (Projection): 1.8
  - 2015 (Projection): 1.8
- Public consumption (percent change):
  - 2010: 0.2
  - 2011: 1.2
  - 2012: 3.2
  - 2013: 3.0
  - 2014 (Projection): 1.7
  - 2015 (Projection): 0.9
- Gross fixed investment (percent change):
  - 2010: 4.8
  - 2011: 4.6
  - 2012: -0.3
  - 2013: 1.7
  - 2014 (Projection): 3.0
  - 2015 (Projection): 2.7
- Inventory accumulation (contribution to growth):
  - 2010: 0.5
  - 2011: -0.1
  - 2012: -0.6
  - 2013: -0.4
  - 2014 (Projection): -0.4
  - 2015 (Projection): -0.3
- Foreign balance (contribution to growth):
  - 2010: 0.5
  - 2011: 0.2
  - 2012: 0.0
  - 2013: 0.4
  - 2014 (Projection): 0.6
  - 2015 (Projection): 0.8
- Nominal GDP (billions of Swiss francs):
  - 2010: 572.7
  - 2011: 585.1
  - 2012: 591.9
  - 2013: 603.2
  - 2014 (Projection): 621.7
  - 2015 (Projection): 641.3
- Gross national saving (percent of GDP):
  - 2010: 35.0
  - 2011: 30.2
  - 2012: 30.6
  - 2013: 30.7
  - 2014 (Projection): 31.2
  - 2015 (Projection): 31.3
- Gross domestic investment (percent of GDP):
  - 2010: 20.3
  - 2011: 21.3
  - 2012: 21.0
  - 2013: 21.1
  - 2014 (Projection): 21.3
  - 2015 (Projection): 21.5
- Current account balance (percent of GDP):
  - 2010: 14.8
  - 2011: 9.0
  - 2012: 9.6
  - 2013: 9.6
  - 2014 (Projection): 9.9
  - 2015 (Projection): 9.8
- GDP deflator (percent change):
  - 2010: 0.3
  - 2011: 0.4
  - 2012: 0.1
  - 2013: 0.0
  - 2014 (Projection): 0.9
  - 2015 (Projection): 0.9
- Consumer price index (percent change):
  - 2010: 0.7
  - 2011: 0.2
  - 2012: -0.7
  - 2013: -0.2
  - 2014 (Projection): 0.2
  - 2015 (Projection): 0.5
- Nominal wage growth:
  - 2011: 0.8
  - 2012: 1.0
  - 2013: 0.8
  - 2014 (Projection): 0.7
  - 2015 (Projection): 0.8
  - 2015 (alternate entry later in table): 1.0
- Unit labor costs (total economy):
  - 2010: -2.3
  - 2011: 2.1
  - 2012: 1.5
  - 2013: -0.3
  - 2014 (Projection): -0.3
  - 2015 (Projection): 0.1
- Unemployment rate (in percent):
  - 2010: 3.5
  - 2011: 2.8
  - 2012: 2.9
  - 2013: 3.2
  - 2014 (Projection): 3.2
  - 2015 (Projection): 3.0
- Output gap (in percent of potential):
  - 2010: -0.5
  - 2011: -0.4
  - 2012: -1.2
  - 2013: -1.0
  - 2014 (Projection): -0.7
  - 2015 (Projection): -0.2
- Potential output growth:
  - 2010: 1.6
  - 2011: 1.7
  - 2012: 1.8
  - 2013: 1.8
  - 2014 (Projection): 1.8
  - 2015 (Projection): 1.8
- General government finances (percent of GDP):
  - Revenue:
    - 2010: 32.9
    - 2011: 33.5
    - 2012: 33.1
    - 2013: 33.3
    - 2014 (Projection): 32.8
    - 2015 (Projection): 33.0
  - Expenditure:
    - 2010: 32.8
    - 2011: 33.2
    - 2012: 33.2
    - 2013: 33.3
    - 2014 (Projection): 33.0
    - 2015 (Projection): 32.6
  - Balance:
    - 2010: 0.1
    - 2011: 0.3
    - 2012: 0.0
    - 2013: 0.0
    - 2014 (Projection): -0.2
    - 2015 (Projection): 0.4
  - Cyclically adjusted ordinary balance:
    - 2010: 0.3
    - 2011: 0.5
    - 2012: 0.4
    - 2013: 0.4
    - 2014 (Projection): 0.1
    - 2015 (Projection): 0.5
  - Gross debt (percent of GDP):
    - 2010: 48.5
    - 2011: 49.1
    - 2012: 50.1
    - 2013: 49.4
    - 2014 (Projection): 48.1
    - 2015 (Projection): 47.3
- Monetary and credit (percent change, averages):
  - Broad money (M3):
    - 2010: 6.4
    - 2011: 6.9
    - 2012: 8.0
    - 2013: 9.7
  - Domestic credit, non-financial:
    - 2010: 2.1
    - 2011: 3.7
    - 2012: 5.3
    - 2013: 3.9
  - Three-month SFr LIBOR:
    - 2010: 0.2
    - 2011: 0.1
    - 2012: 0.1
    - 2013: 0.0
  - Yield on government bonds (7-year):
    - 2010: 1.3
    - 2011: 1.2
    - 2012: 0.4
    - 2013: 0.6
- Exchange rates (levels):
  - Swiss francs per U.S. dollar (annual average):
    - 2010: 1.0
    - 2011: 0.9
    - 2012: 0.9
    - 2013: 0.9
  - Swiss francs per euro (annual average):
    - 2010: 1.4
    - 2011: 1.2
    - 2012: 1.2
    - 2013: 1.2
  - Nominal effective rate (avg., 2005=100):
    - 2010: 128.0
    - 2011: 137.7
    - 2012: 137.8
    - 2013: 140.1
  - Real effective rate (avg., 2005=100) 3/:
    - 2010: 110.1
    - 2011: 114.2
    - 2012: 111.6
    - 2013: 112.0

*Italic: IMF staff report excerpt and related Executive Board and Swiss authorities statements (April 30, 2014) contained in the provided content unit.*

### introduction of the Solvency II framework in the European Union, it is important to note that

### _cr14142 - introduction of the Solvency II framework in the European Union, it is important to note that

### Solvency II framework measures for insurers
- The measures are described as 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.
- These measures 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 (PFMIs)
- 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.

*Source: _cr14142 - introduction of the Solvency II framework in the European Union, it is important to note that*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14142.pdf_