Switzerland--2012 Article IV Consultation—Concluding Statement

March 20, 2012

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.

Bern, March 20, 2012

The Swiss economy is fundamentally strong. However, it is currently facing a number of challenges. Headwinds from the euro area debt crisis and a strong currency have slowed growth, created deflationary pressures, and forced the SNB to abandon the floating exchange rate regime. The financial sector is adapting to the new, more stringent regulatory environment but remains vulnerable. In addition, exceptionally low domestic interest rates have heightened concerns of a housing bubble. The fiscal position is sound, but pressures from population aging are building up. Against this background, we encourage the authorities to:

  • Return to a freely floating currency once inflation goes back to comfortable levels and growth picks up.
  • Press large banks to move faster to strengthen the quality of their capital, which remains low in comparison to peers and in light of risks.
  • Include affordability limits for mortgages in the new macroprudential toolkit to strengthen safeguards against a potential housing bubble.
  • Stand ready to use the limited space available under the fiscal rules to support aggregate demand if needed. At the same time, accelerate reforms to reduce population aging costs.

I. Outlook and risks

1. Growth is expected to remain weak in the first part of this year and regain momentum thereafter, but uncertainty is high. Slower export demand in trading partners and reduced competitiveness in some sectors will continue to curb economic activity in the first part of the year, while inflation will remain low as the exchange rate appreciation is passed on to imported good prices. A recovery is expected in the second half of the year as global demand picks up and the sizable inflation differential with trading partners improves competitiveness. Driven by ample liquidity, domestic credit and real estate prices will continue to rise briskly and construction activity will remain strong. The main risk to this outlook is that a worsening of the euro zone crisis will cause an adverse external and, possibly, financial shock. Direct exposure to weaker euro zone countries in the Swiss financial sector is moderate, but there may be additional strain from market illiquidity, increased counterparty risk, and losses on indirect exposures.

II. Monetary and exchange rate policies

2. The introduction of the exchange rate floor by the SNB in September 2011 was an appropriate policy response to the risk of a sharp economic contraction and deflation caused by a rapid exchange rate appreciation. With economic indicators pointing downwards, negative inflation, and uncertainty in the euro area spurring capital inflows and pushing the exchange rate rapidly to historic heights, the risk was sizable that exchange rate appreciation might lead to entrenched deflation and a recession. Furthermore, alternative policy options were limited, with interest rates at the zero bound, fiscal policy governed by the debt brake rule, and quantitative easing limited by the small size of the domestic bond market. The SNB exchange rate commitment, which is seen as credible by the markets, has stabilized the currency and is thus helping shore up the economy.

3. Once economic conditions normalize, a return to a freely floating currency would be desirable. While the exchange rate floor has been successful, once an economic recovery gets under way and deflation risks recede the SNB should move back to a free float. Delaying exit could carry the risk of stoking inflation, especially in case money supply has to be expanded pro-cyclically to absorb renewed capital inflows. On the other hand, if capital inflows intensify while the economy is still weak, then intervention to defend the floor would appropriately result in a more expansionary monetary stance.

III. Fiscal policy

4. The current fiscal stance is appropriate, but to the extent that it is feasible under the well proven framework of fiscal rules and federalism, fiscal policy should stand ready to support the still fragile economic growth. From a longer-term perspective, a conservative fiscal policy is appropriate in view of potential fiscal risks related to the financial sector (including cantonal banks and public pension funds) and the cost of an aging population. Budget plans for 2012 envisage a broadly neutral stance, which is appropriate under current economic circumstances. However, available leeway under the fiscal rules and additional room that may emerge during budget implementation should be used to prop up aggregate demand if the envisaged recovery stalls in the course of the year.

5. In parallel, measures to tackle the financial consequences of population aging should gain center stage and include additional “fiscal rules”. Under unchanged policies, the increase in aging-related expenditure will already start to bite in earnest around the end of this decade. Consequently, time for reform preparation and implementation is running out quickly. Specifically in the pension system, equalization of the male and female retirement age and pension indexation to inflation only (rather than both inflation and wages) could be considered. Most important, drawing from the experience of other countries, a specific “fiscal rule” that automatically links the retirement age and/or pension benefits to life expectancy could be introduced. Such a rule would reduce the need for repeated and often difficult reform discussions. In the health care area, recent reforms, including with respect to hospital financing, are welcome and should be carefully monitored. Further strengthening of coordination mechanisms, including across government levels, could facilitate the design of additional measures.

IV. Financial and Macroprudential Policies

6. With the two large banks still highly leveraged and reliant on low quality capital (including relative to peers), rapid implementation of Basel III and TBTF capital requirements as well as progress on bank resolvability are paramount. The TBTF legislation, recently approved by Parliament, will substantially raise the requirements for high quality capital in systemically important banks and is commendable. Because of the relatively long implementation period (until 2019, as for the Basel III capital rules), however, banks will be allowed to operate with a thin layer of high quality capital for some time yet, while the global financial system remains fragile. The subdued profitability prospect of the two banks makes it difficult to improve the capital quality by retained earnings only. While raising capital in current market conditions may be costly, in a stress scenario this cost may become prohibitive. In light of these risks, the authorities should press systemically important banks to raise the quality of their capital more rapidly. Since more capital alone cannot fully eliminate TBTF risk, ongoing progress toward improving bank resolvability is welcome.

7. The risk of a real estate bubble has increased. As monetary conditions loosened in 2008, housing price growth accelerated and there are signs of overheating in some “hot spots” and market segments, as well as evidence of loose mortgage lending policies. Since monetary conditions are unlikely to be tightened for some time, the risk that a bubble may form is intensifying. Domestically-oriented banks (and to a more limited extent, the insurance sector) are exposed to the domestic real estate market through both credit and interest rate risk. The latter is building up as longer-term mortgages at low fixed interest rates are becoming more widespread.

8. A broad set of macroprudential instruments is urgently needed to address mortgage market risks. The authorities are stepping up monitoring and supervision, including through a new survey of lending practices and new guidelines for mortgage lending. They are also moving to bolster the macroprudential framework. A joint working group of the Federal Department of Finance, FINMA, and the SNB has proposed a framework to implement the Basel III counter-cyclical capital buffer and increase the weights on riskier mortgages in the calculation of bank capital needs. Swift adoption of these proposals is desirable, as the new tools, if utilized, will provide banks with a larger buffer to absorb mortgage-related losses. As these measures may not fully prevent imprudent lending and borrowing behavior, however, more direct tools such as minimum affordability ratios should also be included in the toolkit, as they are likely to have a stronger preventive effect. The working group also usefully recommends to broaden the SNB’s access to bank information (only if not already available from FINMA) to help the central bank better fulfill its macroprudential oversight responsibilities. Furthermore, consideration should be given to reducing tax incentives for households to take on mortgage debt.

9. Efforts to upgrade microprudential supervision are welcome and more progress is encouraged. FINMA has adopted a risk-based approach in all areas of supervision and increased on-site reviews and regulatory audits, though reliance on external auditors (hired by the banks) continues to be widespread. Resources should be further expanded to broaden FINMA’s in-house supervisory capacity.

10. In the insurance sector, the implementation of the Swiss Solvency Test (SST) by all insurers is an important step forward. The test has helped improve the solvency and risk management of insurers, who are coping with low interest rates and strong competition. The FINMA approval process for internal models used in the SST is making good progress. In addition, given the relatively high level of intra-group balances in insurance companies, the current monitoring of intra-group transactions by FINMA is welcome, but needs to be strengthened to contain contagion risk.


We thank the authorities and all our other counterparts for their hospitality and the open and fruitful discussions.


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