On May 8, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Switzerland.¹

Background

With the exchange rate floor in place for over a year, the Swiss economy has been relatively stable, though GDP growth decelerated, and inflation remains negative. While overall export growth is weak, the external position remains comfortable reflecting high investment income and strong export performance in some sectors. The economy is expected to regain momentum only gradually, in line with a baseline scenario of subdued global recovery.

Managing the new exchange rate regime has required large foreign exchange interventions. When safe haven pressures resumed in mid-2012, the Swiss National Bank (SNB) intervened heavily to defend the floor. As a result, its foreign exchange reserves increased by over 65 percent and its balance sheet reached 85 percent of GDP, the largest among major central banks. The expansion in reserves was largely matched by an increase in bank sight deposits (excess reserves) at the SNB.

Historically, low interest rate and abundant liquidity are fueling the housing and mortgage market. Mortgage lending has grown at about 5 percent per year since 2009, and mortgage debt recently reached over 140 percent of GDP, high in both international and historical comparisons. The authorities have taken several measures to contain risks, including prudential measures to tighten lending standards and conditions, and the recent activation of the countercyclical capital buffer.-

The financial sector is restructuring to adapt to the more stringent regulatory environment, while the banking resolution framework has been reformed. Basel III capital requirements were introduced at the beginning of this year and the Swiss “Too-Big-To-Fail” legislation requires large banks to hold additional buffers. Despite high regulatory capital ratios, the leverage of the two big banks is high compared with other global banks and improved only modestly, as the new minimum regulatory leverage ratio is gradually being phased in and does not bind yet. A new Banking Insolvency Ordinance went into effect in 2012 while cross-border resolution remains to be addressed.

The fiscal position is healthy and government debt low, with a broadly neutral stance projected for 2013. The “debt brake” rule has underpinned remarkable fiscal discipline and public debt is on a firm downward path. However, there are long-term challenges from population aging, which a recently published “Pensions 2020” reform program aims to address.

Executive Board Assessment

Executive Directors noted that, notwithstanding Switzerland’s stable economy and strong policy frameworks, risks stemming mostly from the euro area crisis and vulnerabilities in the domestic financial sector clouded the near-term outlook. Accordingly, they encouraged the authorities to remain vigilant and persist in their steadfast pursuit of pragmatic and forward-looking policies.

Directors agreed that the exchange rate floor has helped safeguard macroeconomic stability in turbulent times. They shared the view that it should remain in place for now, given low inflation, subdued growth, and the threat of further capital inflows. While recognizing the need for caution in implementing unconventional measures, many Directors encouraged the authorities to consider introducing negative interest rates on excess bank reserves if appreciation pressures reappear. The authorities should also take full advantage of any capital outflows to unwind past currency interventions. More broadly, Directors noted that the exchange rate floor policy has expanded the SNB’s balance sheet to an unprecedented size and encouraged the authorities to step up profit retention and capital building.

Directors commended the authorities for their prudent fiscal policy underpinned by the debt-brake rule. Many Directors agreed with the authorities that, barring a deterioration of the outlook for domestic demand, only automatic stabilizers should provide countercyclical fiscal support. Some Directors, however, considered that the current expansionary monetary stance could be usefully complemented by some fiscal support within the boundaries of the debt-brake rule.

Directors welcomed the steps taken to contain risks in the mortgage and real estate markets, including the activation of counter-cyclical capital buffers. They nonetheless counseled the authorities to lay the groundwork for additional policy actions, including tax reforms and affordability limits, if vulnerabilities in these markets do not abate.

Directors commended the authorities for the timely implementation of Basel III regulations, the “too-big-to-fail” legislation, and the reform of the bank resolution framework. Noting that systemically important banks with global reach have improved their capital ratios in part through a reduction in risk-weighted assets, they urged the authorities to monitor the capitalization and restructuring plans of these banks to ensure that leverage is quickly brought in line with peers. Directors also welcomed the significant steps in improving the bank resolution framework, but stressed the importance of addressing the cross-border dimension to fully ensure global resolvability.