Swiss National Bank and Swiss Franc’s Role in Global Financial Markets

Abstract

The Swiss National Bank (SNB) is Switzerland’s reliable, conservative, and independent central bank. Its mandate is to ensure price stability with due consideration for the economy’s development. As the nation’s monetary authority, ultimate source of bank liquidity, and lender of last resort, the SNB has kept Switzerland’s inflation low relative to other countries, mitigated systemic financial risks, provided efficient payment services, participated in multilateral global organizations, and compiled useful statistical data. The SNB’s effectiveness, combined with Switzerland’s lack of commercial and financial restrictions, political neutrality, direct democracy, moderate taxes, and fiscally disciplined governments, have appreciated the Swiss franc’s value and made it a haven in times of international turmoil. Digitalization, cryptocurrencies, and central bank digital currencies are challenges the SNB faces.

Introduction

For more than a century, Switzerland has enjoyed a relatively high level of political and fiscal stability, low government debt, and a well-functioning system of legal institutions, all of which have contributed to the strong demand for Swiss francs and Swiss-franc-denominated direct and financial investments. During crises, the Swiss franc has often served as a safe haven currency, causing heavy capital inflows and substantial currency appreciations. The attributes that have attracted foreign capital to Switzerland stem mainly from its relative lack of commercial and financial restrictions, political neutrality, direct democracy, low inflation rate, moderate taxes, and fiscally disciplined (federal, cantonal, and municipal) governments. Of prime importance, the Swiss franc’s international appeal and relative strength have been due to a prohibition on the central bank’s ability to lend directly to the Confederation. During periods of rapid currency appreciation, Swiss companies have struggled to maintain their international competitiveness, but the longer-term effects of the currency’s strength have been generally beneficial. An appreciating franc has forced Swiss companies to remain flexible and innovative. It has dampened the rise in consumer prices by making imports more affordable, and net capital inflows have helped keep Switzerland’s real interest rates among the lowest in the world.

Crucial to Switzerland’s success has been its reliable, conservative, and independent central bank, which has played a vital role in supporting the nation’s efficient money and capital markets. Keeping prices relatively stable and effectively allocating financial resources have supported Switzerland’s economic growth at sustainable rates. As the ultimate source of liquidity for the nation’s banking system and lender of last resort during financial hardships and crises, Switzerland’s central bank has mitigated possible systemic financial risks, provided the market with banking services that facilitate transactions, participated in multilateral global organizations, and compiled useful statistical data.

Overview of the Swiss National Bank

The Swiss National Bank (“SNB” or “Bank”) is Switzerland’s central bank. The Swiss Parliament (i.e., Federal Assembly) created the SNB in 1905 as a special-statute, quasi-public, joint-stock company.¹ In 1906, the Federal Act on the Swiss National Bank (National Bank Act , NBA ) went into force, and a year later, the SNB started business, gaining specific responsibilities and powers related to the nation’s financial stability and soundness.

The Bank is located in eight regions, with headquarters in Bern and Zurich and six representative offices in Basel, Geneva, Lausanne, Lucerne, Lugano, and St Gallen. Since 2012, the SNB has had a branch office in Singapore to keep the SNB’s Governing Board informed of regional economic conditions and communicate SNB policies to areas around the country. In addition, 13 canton-operated agencies assist the SNB with banknote distribution.²

SNB shares are registered and listed on the Swiss stock exchange. Approximately 78% of them are owned by public shareholders, such as cantons, cantonal banks, and other public law institutions, such as municipalities. Private investors hold the remaining 22%.³ The Swiss Confederation cooperates with the SNB but holds none of its share capital, fixed at 25 million Swiss francs , with 100,000 registered shares , each carrying a nominal value of 250 Swiss francs .⁴

The NBA defines shareholder rights. To prevent excess power in the hands of one or a few, limitations are placed on the number of SNB shares any individual can hold. Furthermore, private shareholders’ voting privileges are limited to 100 shares, and dividends cannot exceed 6% of the SNB’s nominal share capital (i.e., 6% × CHF 250 per share = CHF 15 per share). The remaining profits are paid to “the public,” which means distributing them to the Confederation and cantonal shareholders (i.e., cantons and cantonal banks). The rights of SNB shareholders are further diminished by empowering the Federal Council to appoint a majority of the SNB’s 11-member Bank Council, including the President and Vice President. The Federal Council also appoints all three members (and three alternate members) of the Governing Board, including the chairman and vice chairman.

The SNB’s late appearance relative to other European central banks was due to the nation’s lack of uniform currency laws, inconsistent bank note regulations, and relatively moderate credit demands.⁵ Article 36 of Switzerland’s first Federal Constitution in 1848 transferred the right of coinage from cantons to the Federal Confederation, in effect giving the central government authority to administer the nation’s currency. After that, the demand for Swiss franc funds increased rapidly. Nevertheless, it took more than a half-century to establish the SNB. A significant step along the way occurred in 1891 when the Swiss federal government gained the constitutional right (Article 39) to be the sole issuer of Swiss franc banknotes. In 1910, the Confederation transferred to the SNB its power to issue Swiss franc banknotes.

Until the 1960s, the SNB acted as a relatively passive monetary authority, increasing the money supply to accommodate an expanding economy and contracting it when the economic growth rate slowed. During the 1960s, this monetary stance changed as international developments prompted the Bank to take a more dynamic role in the economy.

In 1971, the Bretton Woods (Currency) Agreement was abandoned and replaced by the Smithsonian (Currency) Agreement, which lasted only until 1973. Both agreements restricted member countries’ exchange rate movements to a relatively narrow range. With their demise, Switzerland revised, in 1978, its NBA, giving the SNB a full range of monetary tools. Before the revision, the SNB operated primarily based on special legislation.

As critical as the revised NBA was in 1978, the statutory basis for today’s SNB comes from the NBA of 2003,⁶ which lays out the Bank’s mandate, independence , accountability, obligation to set aside reserves, allocation of profits, monetary policy instruments and powers, and organizational structure . From this Act, which came into force on May 1, 2004, the Bank gained the statutory powers needed to use its choice of monetary instruments to provide the Swiss financial markets with liquidity.

The SNB’s Mandate, Goals, Responsibilities, and Strategies

Mandate

Switzerland’s Federal Constitution⁷ and NBA ⁸ mandate the SNB’s independence and responsibility to conduct monetary policies transparently and for the nation’s benefit as a whole. The NBA defines these responsibilities more concretely than the Constitution by specifying the SNB’s duty to “ensure price stability” with due consideration for the economy’s development (Article 5).

Independence

A central bank’s “independence” can be inferred from its ability to control impactful monetary instruments and its freedom from outside influence, particularly when setting monetary policies and choosing and replacing personnel, such as the governor, board, and council members. Switzerland’s Federal Constitution and the NBA established the Central Bank’s right to operate independently, resulting in the SNB having considerable functional, political, financial, institutional, and personnel autonomy.

Functional and political independence stem from prohibitions on the Bank seeking or accepting instructions from the Federal Council, the Federal Assembly, or any other political body while fulfilling its monetary tasks.⁹ More autonomy comes from a prohibition on granting loans or overdraft facilities to the Confederation. The SNB’s financial (i.e., budgetary) independence results from its power to self-finance operations by acquiring interest-earning and other assets with the monetary base it creates. Institutional autonomy is grounded in the SNB’s independent organizational structure . Finally, its personnel independence springs from the six-year terms of the SNB’s Governing Board members, who may be removed from office only if they cannot exercise their duties or commit significant authority breaches of the law. The Confederation’s Federal Council (Bundesrat) cannot appoint SNB Governing Board members unless the SNB’s Bank Council first recommends them. Therefore, stacking the SNB with political favorites has been made intentionally difficult.

Additional support for the SNB has come from Switzerland’s underlying belief that an independent central bank increases the chances of aligning monetary policies with the country’s long-term interests. In short, Switzerland accepts the countless academic studies showing that, for developed countries, there is a high correlation between low inflation and central bank independence, so long as the central bank acts within the bounds of its mandate (i.e., independence is not freedom to do anything).¹⁰

Transparency

Even though the SNB’s independence is constitutionally guaranteed, this freedom has some significant limitations because the Bank is accountable to Switzerland’s Federal Council, Parliament, and the public.¹¹ The NBA mandates that the SNB’s operations be conducted transparently and, to this end, places threefold accountability on the Bank. First, it must regularly discuss economic conditions and monetary policies with the Federal Council , particularly in the context of federal fiscal policies. Second, it must submit a written Annual Report to the Federal Assembly, including an Accountability Report and a Financial Report. The Accountability Report describes the SNB’s monetary policies and their implementation, along with whether the SNB has met its responsibilities. The Financial Report explains the SNB’s health as understood through its financial statements (i.e., balance sheet, income statement , and notes). The obligation to explain Switzerland’s economic situation, monetary policies, and their intended effects also extends to responsible federal committees.

Finally, the Bank must inform the public of its actions and does so through its Quarterly Bulletin, Annual Report, and Financial Stability Report, which is an annual publication that addresses the health of Switzerland’s banking sector. The SNB also uses popular channels, such as YouTube, Twitter, and its website (www.snb.ch) to communicate with the public through multilingual videos, news recordings, press releases, statistical reports, and posts.

Cooperation

The SNB cooperates with the Swiss Financial Market Supervisory Authority (FINMA), and the Federal Department of Finance (FDF) to:

• Exchange information on issues related to financial stability and financial market regulation, and

• Promote financial stability, particularly in times of financial crisis.

These responsibilities are enshrined in the trilateral Memorandum of Understanding (January 2011).¹²

The SNB concentrates on macroeconomic, systemic, and macroprudential regulation issues. FINMA’s center of attention is on monitoring individual financial institutions. Among the FDF’s responsibilities are:

• The Confederation’s budget,

• Financial planning,

• Fiscal policies,

• Federal treasury management,

• Ensuring there is financial equality between the federal government and cantons,

• Taxes,

• Human resources,

• Providing IT services for the federal administration, and

• Monitoring the nations’ imports, exports, and transit goods. The FDF is also in charge of the federal mint.

Monetary Policy Goals and Responsibilities

The SNB’s primary goal is to ensure price stability while taking due account of economic developments.¹³ As a practical matter, “price stability” has been defined by the SNB to mean keeping the nation’s medium-term inflation rate between 0 and 2% per year.

Switzerland’s Constitution and NBA prioritize price stability in the SNB’s mandate, which helps to explain many of the tough decisions the Bank has needed to make. For example, the choice in January 2015 to abandon Switzerland’s euro currency peg had a detrimental effect on the country’s export sector¹⁴ and was criticized by many industry participants and observers.¹⁵ Nevertheless, by considering the SNB’s mandate and priorities, this decision can be fully understood. In general, the Swiss economy has learned to get by with a strong Swiss franc and, so far, may have been strengthened by it because currency appreciation forced Swiss companies to operate efficiently and remain innovative.

The Bank contributes to systemic financial stability by facilitating and securing the functioning of Switzerland’s cashless payment systems, counterparties, and security depositories.¹⁶ With these responsibilities and the tools to achieve them, the SNB has been well-equipped to protect Switzerland from technical problems or failures that might spread from one financial institution or sector to another. To ensure the SNB serves the “nation as a whole,” it is not permitted to favor or disfavor any region, industry, group, or cause.¹⁷

In addition to the responsibilities mentioned above, the NBA holds the SNB accountable for:

• Ensuring the supply and distribution of cash—both notes and coins¹⁸;

• Holding sight deposit accounts for banks (e.g., for clearing and reserve requirement purposes) and other market participants, such as insurance companies and fund management firms;

• Managing currency reserves, which include foreign-currency-denominated investments, gold holdings,¹⁹ the SNB’s reserve position in the International Monetary Fund (IMF), and its IMF Special Drawing Rights ²⁰;

• Providing the Swiss Confederation with banking services (i.e., acting as the government’s fiscal agent), such as issuing money market debt register claims and bonds, serving as the paying agent for coupons, bond repayments, and money market debt register claims, managing the Confederation’s securities custody accounts, providing technical and advisory financial assistance, and conducting money market and foreign exchange transactions;

• Collecting and publishing statistical information on banks, real estate, and financial markets, and

• Participating with foreign central banks and cooperating with international organizations, such as the Bank for International Settlements (BIS), IMF, Financial Stability Board (FSB),²¹ and the Organization for Economic Cooperation and Development (OECD ).

Environmental Sustainability

Since 1996, the SNB has chosen environmental sustainability as one of its goals by implementing eco-friendly management policies that reduce resource consumption. The SNB’s annual Sustainability Report now contains a separate section on “Environment,” which focuses on conserving natural resources, environmental performance, and climate protection. The SNB’s operational sustainability pays particular attention to the Bank’s inter-relationships with employees, society, and the environment. When it comes to implementing monetary policies and managing its balance sheet, the SNB tries to account for all relevant risks, including those linked to the climate. The central bank’s position is that “it is not desirable for the SNB to pursue specific structural or societal policy objectives. To do so might hinder the implementation of independent and credible monetary policies.”²² In short, unless environmental, political, and social changes impact the stability of Switzerland’s financial system , they are better managed at the governmental level.

Profitability

Because the SNB has a constitutional obligation to pursue monetary policies that serve the nation’s overall interests, its primary responsibilities are monetary policy and financial stability—not earning profits. SNB profits are tax-exempt. A portion of them is retained and allocated to Provisions for Currency Reserves, which is part of the Bank’s equity. If net profits are positive after these provisions, the remainder is distributed to shareholders, the Confederation, and cantons.²³ Of the remaining net profits, the Bank is permitted to pay dividends to shareholders not exceeding 6.0% of its share capital. Finally, one-third of any remaining net profits is distributed to the Swiss Confederation and two-thirds to the Swiss cantons , in proportion to their respective populations. This distribution rule, which the Constitution and NBA set, severely limits shareholder dividend payments. During most years, the major portion (by far) of net profits (after provisions ) go to cantons and the Confederation.

Annual allocations to the SNB’s provisions for currency reserves are made regardless of whether yearly results are positive or negative. Losses or insufficient profits impact the Bank’s distribution reserve, which could cause it to be negative, as was the case during 2013.²⁴

Under the Bretton Woods and Smithsonian Agreements, the SNB had little opportunity to earn profits. The collapse of these agreements in 1971 and 1973, respectively, allowed the Swiss franc to fluctuate against other currencies. Through the 1970s and 1980s, the SNB’s foreign exchange reserves rose relative to its gold holdings, and its portfolio of securities increased in tandem with its open market operations. As a result, movements in exchange rates and interest rates caused significant changes in the SNB’s profits and problematic fluctuations in its distributions to the Confederation and cantons. The underlying reason for the SNB’s profit volatility was (and is) its mismatched balance sheet, with large foreign currency-denominated assets paired with Swiss franc liabilities. Private institutions might hedge this foreign-currency risk, but the SNB does not. One reason is the act of hedging could appreciate the Swiss franc’s value and undermine the reason intervention was taken in the first place.

Pressure built during the 1980s to smooth these annual distributions and bring greater stability to Confederation’s and cantons’ budget planning. Any suitable agreement rested on four central pillars.

• 1. Distributions could not put pressure on the SNB to earn profits at the expense of price stability;

• 2. Distributions could not influence the domestic monetary base;

• 3. The SNB’s unhedged foreign exchange reserves should grow with the rate of nominal gross national product (GNP), and

• 4. Current distributions should be based on past profits.

In 1991, an agreement was reached to distribute a maximum of CHF 600 million per annum to the Confederation and cantons, with lower distributions possible if the SNB’s profits waned. Any surpluses would be allocated to provisions. Distributions were lagged one year, which meant payments on January 1, 1993 were based on profits in 1991.²⁵

The 1991 agreement continued until 1997, when the NBA was revised and expanded the SNB’s investment capabilities, which led to a considerable and controversial reduction in gold holdings and an increase in interest-earning financial assets. This revision, together with continuing pressure by the Confederation and cantons for greater stability, led to a series of refinements in subsequent years that changed the distribution smoothing process and payment amounts. These alterations were based on evolving conditions and included:

• Setting fixed periods for each agreement, such as two, five, and ten years,

• Inserting clauses that allowed for increases and decreases in fixed annual distributions, plus the possibility of supplementary payments, when SNB profits warranted them²⁶;

• Raising payments to eliminate the SNB’s large distributable surplus;

• Basing the growth of SNB provisions on gross domestic product (GDP) instead of GNP;

• Linking distributions to the SNB’s gold sales, and

• Preserving the principle that fixed Confederation and canton distributions should be stabilized and maintained over the medium term.

The two most recent distribution agreements are illuminating. The first one, from 2016 to 2020, set the Confederation’s and the cantons’ fixed annual payments at CHF 1 billion but paid them only if (1) net profits were positive after making provisions for currency reserves and (2) the SNB’s distribution reserves (i.e., retained earnings) were not negative.²⁷ For years when the Bank made no distributions, extra payments in subsequent years could compensate, so long as the SNB’s “Provisions for Currency Reserves ” permitted it. If the distribution reserve exceeded CHF 20 billion, the Confederation and cantons could receive a maximum of CHF 2 billion.²⁸ In February 2020, a supplementary agreement between the FDF and SNB provided an additional allocation of up to CHF 2 billion (i.e., up to a total of CHF 4 billion) for 2019 and 2020.

The newest FDF-SNB agreement (i.e., 2020 to 2025) provides net profit distributions on a sliding scale. Starting from a base distribution of CHF 2 billion, if net profits are at least CHF 2 billion, supplementary allocations of CHF 1 billion will be made if net profits reach CHF 10 billion, CHF 20 billion, CHF 30 billion, and CHF 40 billion. Therefore, the agreement allows a maximum of CHF 6 billion of net profit distributions to the Confederation and cantons.²⁹

Monetary policy has a powerful political nature, which is why the Swiss Parliament has frequently discussed the SNB’s profits and how to allocate them. Numerous proposals have been made, with no objective solution in sight. If 2022 proved anything, it was that neither SNB profits nor distributions to the Confederation and cantons are guaranteed.

Organizational Structure

The SNB is divided into three departments, whose main organizational units are located at the Zurich and Berne head offices.³⁰ Each department has been assigned specific activities and responsibilities and is headed by a Governing Board member.³¹

Bank Council

The Bank Council oversees and controls the SNB’s organization and conducts the nation’s monetary policies. Its responsibilities include (among other things) overseeing the SNB’s investment assets, risk management practices, the appointment of affiliate management members, and staff remuneration. It consists of 11 members, of which six are appointed by the Federal Council and five by an annual shareholders’ meeting in April. Members are elected for four-year terms, and their entire duration of service cannot exceed 12 years. Eligibility criteria include “knowledge of the fields of banking and financial services, business administration, economic policy, or an academic field.”³² As with the Governing Board (see next section), Bank Council members must be Swiss citizens and have impeccable reputations. A Memorandum of Understanding between the FDF and the SNB ensures that the Bank Council members are geographically, linguistically, and gender-balanced, with specialized expertise, abilities, and qualities essential to its proper functioning.³³

Governing Board

The Governing Board is the SNB’s top management and executive body. It is composed of a chairperson, vice-chairperson, and third member. This Board has overall responsibility and accountability for monetary policy, investments, currency reserve composition, and cooperation with other central banks and international organizations, such as the IMF, BIS, FSB, OECD, and Network for Greening the Financial System (NGFS). In addition, the Governing Board represents the SNB in public. Upon recommendations from the Bank Council, the Federal Council elects Governing Board members for six-year terms.³⁴ The Enlarged Governing Board , composed of the Governing Board and Alternate (Deputy) Members, is responsible for the SNB’s operational management. As a rule, the Governing Board holds two ordinary meetings per month, though extraordinary meetings can be called quickly and at any time.³⁵

Audit Board

The Audit Board is elected annually at the Shareholders’ Meeting and consists of one or more natural persons or legal entities. It is responsible for ensuring that SNB accounting complies with statutory requirements.

The SNB’s Monetary Policy Instruments

The arsenal of monetary instruments at the SNB’s disposal is broadly defined in the NBA and the National Bank Ordinance.³⁶ Further details are spelled out in the Guidelines of the Swiss National Bank on Monetary Policy Instruments ³⁷ and Investment Policy Guidelines of the Swiss National Bank .³⁸ Guidelines of the Swiss National Bank on Monetary Policy Instruments describes the tools, terms, and procedures used by the SNB to implement monetary policies. Investment Policy Guidelines of the Swiss National Bank define the scope, policy principles, eligible asset categories, and risk control processes of the SNB’s investment activities. The Bank’s Terms of Business and Instruction Sheets ³⁹ complement and enhance these Guidelines.

The Terms of Business document regulates the transactions in which the SNB may participate. Its five chapters explain:

• “General conditions,” which include authority to sign, communications, liability, charges, notice of termination, and data protection⁴⁰;

• “Payment transactions,” which include admission to the giro system, sight deposit account conditions, check transactions, collection, and cash transactions;

• “Repo transactions” concerning open market operations and standing facilities;

• “Foreign exchange and gold transactions,” and

• “Custody services.”

The Instruction Sheets are more detailed than the Guidelines, describing specific policies, conditions, and procedures for:

• Open market operations;

• The intraday (liquidity) facility;

• The liquidity-shortage financing facility;

• The custody cover account;

• Collateral eligible for SNB repos, and

• Sight deposit accounts.

The Bank’s monetary tools are used to provide liquidity to the money market or absorb it and allow the SNB to act as a lender of last resort for individual Swiss banks and the banking system.⁴¹

The SNB’s Main Monetary Tools

The SNB conducts monetary policies using foreign exchange and swap transactions, open market operations, standing facilities, and other financial tools.

Foreign Exchange Market Purchases, Sales, and Swaps

The SNB conducts its foreign exchange market interventions in the spot and forward markets. Spot-market interventions affect the Swiss franc’s international value and the nation’s monetary base. Purchases of foreign currencies (with Swiss francs) simultaneously tend to lower the Swiss franc’s value, increase currency reserves, and enlarge the nation’s monetary base. By contrast, Swiss franc purchases (with foreign currencies) raise the currency’s value, reduce the Swiss monetary base, and deplete the SNB’s foreign-currency assets.

Pressure on the Bank to actively manage exchange rates is understandable due to exports’ critical role in the Swiss economy. Currency appreciation raises export prices relative to foreign markets and lowers import prices, forcing Swiss industries to improve productivity to compete. In the extreme, it could endanger the nation’s international competitiveness and living standards. Therefore, the central bank needs to use this instrument wisely.

Economic logic tells us that no country can simultaneously control its money supply and nominal exchange rate while allowing free international trade and capital mobility. This tradeoff is referred to as the Impossible Trinity. Caution is necessary because, in times of strong short-term capital flight to the Swiss franc, intervention might increase the nation’s monetary base and significantly raise inflation, inflationary expectations, and foreign currency risk.

The SNB also engages in foreign exchange swaps to change money market liquidity. Foreign exchange swaps are combinations of spot and forward transactions, where the buy and sell rates for a currency and the transactions’ maturity are established in advance.⁴²

The SNB has found swaps especially valuable because of their flexible maturities and rates. The Bank typically selects maturities between one week and three months.⁴³ Until 1998, when repurchase agreements were introduced, swap transactions were among Switzerland’s most important monetary policy instruments .

Open Market Operations

Open market transactions are among the SNB’s most important monetary policy instruments, in large part because they require active, rather than passive, actions by the central bank. These monetary activities include the SNB’s repurchase agreement (repo) transactions, primary issuance of SNB Bills, and secondary market purchases and sales of SNB Bills.

Repos

The Bank purchases and sells securities in the open market, thereby increasing or decreasing banks’ reserve balances at the SNB, which are part of the nation’s monetary base. Most of these open market transactions are done using repos and reverse repurchase agreements (i.e., reverse repos). Repos are secured transactions that manage liquidity and interest rate conditions on the money market, where maturities are less than or equal to one year. If the banking system is undersupplied (oversupplied) with liquidity, the SNB provides (absorbs) liquidity by engaging in repurchase and reverse-repurchase agreements. Under a repurchase agreement, a financial institution sells securities at one price (spot transaction) and simultaneously agrees to repurchase the same type and quantity of securities later and at a higher price (forward transaction). The interest paid is the difference between the securities’ purchase and sales prices. In a reverse-repurchase agreement, the purchase and sale are opposite. This way of managing liquidity provides the SNB with a flexible means to implement monetary policies. Because of the strong linkages among money market interest rates of different maturities, the SNB tries to influence the yield curve via changes in short-term interest rates.

In the past, the SNB’s daily money market operations offered or absorbed liquidity for specific counterparties and the market as a whole. The repo maturities varied from overnight to several months, but in general, the SNB used the one-week duration. Daily activity allowed the SNB to adjust money market liquidity and interest rates on a near-continuous basis.

SNB Bills

SNB Bills are tradable, interest-bearing debt certificates with maturities of up to one year. The SNB can issue them at auctions with its counterparties⁴⁴ or through private placements .⁴⁵ First issued in 2007, their purpose was to absorb Swiss franc liquidity. Afterward, the SNB purchased SNB Bills on the secondary market to increase liquidity.

Sizeble foreign currency purchases by the SNB led to excessive increases in banking sector liquidity during the summers of 2010 and 2011, but the Bank issued SNB Bills and absorbed the liquidity quickly. Because the SNB has taken strong measures to reduce the Swiss franc’s value, it suspended new issues of SNB Bills in August 2011, except for test-case operations.⁴⁶

Standing Facilities

Standing facilities provide liquidity for very short-term funding problems, mainly connected to unexpected payments and receipts of financial institutions. In contrast to open market operations and foreign exchange market transactions, standing facilities are passive monetary policy tools because the SNB sets only the conditions under which eligible financial institutions, such as banks and insurance companies, can borrow from it. These facilities offer banks the ability to bridge unexpected liquidity gaps.

The Intraday Facility extends interest-free liquidity to counterparties under the condition that funds are repaid on the same working day. Because these loans are on a repo basis, they are secured with eligible collateral equal to at least 110% of the intraday funds extended. Swiss-franc settlement is handled via Swiss Interbank Clearing (SIC), and foreign exchange transactions are cleared through Continuous Linked Settlement (CLS).

The Liquidity-Shortage Financing Facility funds financial institutions needing liquidity until the next working day. The SNB limits borrowers who deposit collateral in a secure Custody Cover Account “SNB” with SIX SIS Ltd (SIS). This collateral must be maintained constantly at 110% of the limit, with compliance monitored by SIS and account management handled by the borrower. The interest rate charged influences the liquidity that financial institutions set aside. Using this channel as a financing source is relatively expensive because the special lending rate equals the SNB’s policy rate plus a special premium of 0.5%. Regardless, the special lending rate must always be at least 0.0%.⁴⁷ In 2021, the SNB’s “policy rate ” was at minus 0.75%, and the interbank market rate, SARON (Swiss Average Rate Overnight ), was near the policy rate . Due to the premium of 0.5%, liquidity from the Liquidity-Shortage Financing Facility was thus more expensive than the interbank market, thereby making the Bank a genuine “lender of last resort.”⁴⁸

The SNB’s Other Monetary Tools

The SNB has several other tools to influence monetary policy. The most noteworthy are:

• Changing the interest on bank sight deposits at the SNB,

• Derivative transactions, and

• Credit transactions.

Interest (Positive or Negative) on Banks’ Sight Deposits

The SNB is permitted to accept interest-bearing and non-interest-bearing deposits of banks under conditions it determines.⁴⁹ To make Swiss franc investments less attractive and dampen capital inflows that appreciate the Swiss franc , the SNB introduced negative interest rates on banks’ sight deposits . Under normal conditions, it is zero or positive.

Traditionally, bank sight deposits at the SNB were non-interest-earning assets, but that changed in January 2015 when the Bank began charging a 0.75% interest (i.e., imposing an interest equal to—0.75%—negative 0.75%) on them to reduce the general level of Swiss franc interest rates, compared to other currencies. Lower interest rates made Swiss franc investments less attractive, thereby easing upward pressure on the currency. This charge was only on bank deposits that exceeded defined thresholds. In March 2022, the SNB raised its policy rate to + 0.25%.⁵⁰

Swiss Franc Security Sales and Purchases

The SNB is authorized to purchase and sell Swiss-franc-denominated securities to execute its monetary policies.⁵¹ Security purchases increase the nation’s monetary base and overall Swiss market liquidity, while sales have the opposite effect. The SNB is prohibited from acquiring newly issued Confederation, cantonal, or municipality debt securities but may purchase them on secondary markets.

Derivative Purchases and Sales

The SNB is authorized to create, purchase, and sell derivatives with underlying assets, such as receivables, securities, precious metals, or currency pairs. While these actions do not directly affect Swiss franc-spot market prices, arbitrage between the spot and forward markets can cause liquidity changes.⁵²

Credit Transactions

The SNB is authorized to lend to banks and other financial intermediaries so long as the borrower commits sufficient eligible collateral. Consequently, collateral eligibility and counterparty eligibility are critical factors in setting Swiss monetary policies (see the following sections).⁵³

Collateral Eligibility Policies

The SNB determines collateral eligibility using a wide variety of factors, such as the issuer’s credit quality and domicile, and the collateral’s currency-denomination, volume, liquidity, and ability to be delivered through the SIS. For instance, eligible repo securities must be issued by central banks, public sector entities, international or supranational institutions, multilateral development banks, or approved private sector parties. Typically, securities issued by financial institutions are not eligible, except those sold by mortgage-related financial entities, such as Swiss Pfandbrief institutions. Collateral not denominated in Swiss francs must be in Euro-area euros, US dollars, British pounds, Danish kroner, Swedish kronor, or Norwegian kroner. The credit rating of the securities and issuers’ domicile country must be at least at the AA–/AA3 level. Eligible collateral’s liquidity is determined by whether it is traded on a public exchange. The SNB’s collateral framework for accepted currencies is one of the most liberal among central banks, but it sets very high rating standards.

The significance of these collateral policies was especially apparent during the financial crisis from 2007 to 2009, when the price discovery process for securities became problematic, leading to liquidity shortages and economic contraction. In the US dollar market, significant and sudden discounts on repo collateral led to failures in the money market, thereby impairing the ability of banks to lend. By contrast, the secured Swiss interbank market kept functioning during the crisis because the collateral backing repo transactions corresponded to that accepted by the SNB in its repo operations. This highly credible collateral policy resulted in SNB-eligible collateral remaining the standard for secured interbank transactions in the Swiss franc money market. Switzerland’s strict collateral policy had substantial advantages because it reduced the need for discounts with standardized repo transactions—even during market turbulence when other money markets were malfunctioning.⁵⁴ Additionally, it set clear incentives for banks to hold high-quality, liquid assets.

Eligible Counterparties

Domestic and non-resident financial institutions are eligible to engage in SNB repo transactions as long as they hold sight deposits at the SNB and their transactions align with the SNB’s monetary policies. Sight deposits at the SNB are required because the SIS and SIC settle and clear repo transactions. In 1999, the SNB opened access to its monetary policy operations and standing facilities to banks domiciled outside Switzerland. The original intention of allowing non-resident financial institutions to access the SNB’s monetary policy operations remotely was to reduce the dependence on the few large Swiss financial institutions and improve the general liquidity distribution. The SNB applies the same access policy to open market operations and standing facilities.

Settlement of Repo Transactions and SNB Bill Issues

The SIS settles repo and SNB Bill transactions on a delivery-versus-payment (DvP) basis, which means that, simultaneously, securities are delivered to the lender’s SIS account, and funds are credited to the borrower’s SIC account. Counterparty risk is further reduced by marking these securities to market twice daily and covering valuation discrepancies with cash or acceptable securities. Reversing these transactions involves debiting the borrower’s account and crediting the lender’s account, with the applicable interest rate included.

Emergency Liquidity Assistance

The SNB is authorized to extend emergency assistance to one or more domestic banks on an emergency basis. This liquidity assistance is extended only to financial institutions or a group of financial institutions essential to Switzerland’s financial stability. Borrowers must be solvent and able to post sufficient collateral.

Communication

An important, though subtle monetary policy channel is how the SNB communicates its economic outlook to the public. The financial community has come to recognize that even small changes in short-term interest rates can significantly affect the entire yield curve, depending on a central bank’s credibility. By publishing its opinions on current and expected future economic conditions, the SNB has tried to smooth the transition to new monetary policies by making them more transparent and, thereby, reducing volatile market swings due to misinformation and rumors. Suasion power should not be underestimated. It has peaked during times of substantial economic turmoil, volatile exchange rate fluctuations (e.g., 2010, 2011, and 2015), appointments of Bank Council members, and when members of the SNB’s Governing Board resigned (e.g., in 2012).

Minimum Reserves

Before 2004, the NBA allowed the SNB to set reserve requirements for Swiss banks’ short-term deposits. By varying the minimum reserve requirements, the SNB could directly influence the banking system’s ability to create money and credit without changing the level of interest rates via open market operations or foreign exchange market intervention. The reserve requirement tool proved to be rather heavy-handed because it influences all banks regardless of their liquidity positions. Furthermore, increasing minimum reserve requirements might force banks to meet them by refinancing during unfavorable market conditions. It might also lead to distortions due to reallocations of banks’ balance sheet positions.

The NBA’s reform in 2004 came with a new set of minimum reserve requirements and a stipulation that minimum reserves could not exceed 4% of banks’ short-term Swiss-franc-denominated liabilities.⁵⁵ Bank assets that qualify as “eligible reserves” include coins , banknotes, and sight deposits held at the SNB. In 2021, the minimum reserve requirement was 2.5% of customer sight deposits with maturities up to 90 days and 20% of customer savings deposits and investments. It is calculated by dividing “eligible liquid assets” (i.e., cash in the vault and sight deposits at the SNB) by “relevant liabilities ” at the end of the three months preceding the reporting period. “Relevant liabilities ” include short-term liabilities in Swiss francs (up to 90 days) plus a portion of customer savings and investments during the three-month reporting period.⁵⁶ This requirement ensures that Swiss banks have enough funds available and to protect “privileged customer claims” (i.e., sight deposits up to CHF100,000). The liquid assets ratio is updated monthly.⁵⁷ Under the new rules, minimum reserves are no longer required on interbank liabilities if depositing banks are subject to minimum reserve requirements , independently.

Figure 7.1 shows the change in Swiss banks’ eligible assets relative to the minimum required reserves required from 2005 to May 2022. The sharp increase after 2008—particularly after 2011—has been due to the expansion of sight deposits banks held at the SNB, while the volume of banknotes and coins in circulation has remained relatively stable. In 2021, Swiss banks held eligible assets approximately 30 times higher than the required minimum.

Fig. 7.1

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/banken#!/cube/bamire [Accessed on August 25, 2022])

Eligible reserve assets and minimum required reserves: January 2005 to June 2022

SNB Monetary Targets and Policies Since 1944

Three primary factors influence a central bank’s ability to achieve its monetary goals:

• 1. The nation’s exchange rate system;

• 2. Money supply targets, and

• 3. Interest elasticity of demand for credit.

These factors are so intricately intertwined that one cannot be discussed without the others. A central bank sacrifices considerable monetary independence by fixing the exchange rate and, by targeting the money supply, loses significant control over domestic interest rates and currency values. Table 7.1 provides an overview of SNB’s monetary policy targets since 1944. While the SNB considers all relevant factors when determining its monetary policies, tradeoffs have forced the Bank to put its operational emphasis on meeting targets tied to short-term interest rates, exchange rates, or monetary aggregates. Table 7.1 reflects the SNB’s search for an effective monetary target.

Table 7.1 Summary of Swiss National Bank monetary targets since 1944

Bretton Woods and Smithsonian Agreement Parity Rates: July 1944 to January 1973

From 1944 to 1973, Switzerland was part of the Bretton Woods System (July 1944 to August 1971) and the Smithsonian Agreement (December 1971 to January 1973). Both committed the SNB to restrict Swiss franc exchange rate movements to a narrow band around a parity rate tied to the US dollar.⁵⁸ By gearing its monetary policies to offset international currency market forces, the SNB relinquished virtually all control over the domestic money supply during this period. For more than two-and-a-half decades, until 1973, Switzerland’s inflation rate and nominal interest rates were influenced more by external economic events than by the discretionary policies of the SNB.

The gradual erosion of trust in the Bretton Woods and Smithsonian Agreements put upward pressure on the Swiss franc. Their abandonment in 1971 and 1973, respectively, and rising US inflation intensified appreciation pressures. To discourage foreign capital inflows and curtail significant increases in the nation’s money supply, the SNB imposed, almost immediately after the collapse, a 100% minimum reserve requirement on increases in banks’ net deposit liabilities to non-residents. This restriction was followed, in 1971, by a prohibition on interest payments to non-residents.

As upward pressure on the franc continued, the SNB imposed measures that were even more decisive.⁵⁹ In 1972, it prohibited non-residents from purchasing Swiss-franc-denominated, interest-earning securities (i.e., bills, notes, and bonds) and Swiss real estate . Loans to Swiss non-banks located outside Switzerland required special permission, and a penalty charge of 2% per quarter was imposed on increases in non-residents’ Swiss franc deposits .⁶⁰

Short-Term Money Supply Growth Rate: January 1973 to September 1978

With the dissolution of the Smithsonian Agreement in 1973, the Swiss franc was free to float against all major currencies, giving the SNB full control over its monetary base. The Bank used its powers to fight inflation by vigorously enacting restrictive monetary policies. As a result, the nation’s inflation rate fell from 8.8%, 9.8%, and 6.7% in 1973, 1974, and 1975, respectively, to 1.7%, 1.3%, and 1.0% for the years 1976 to 1978, respectively, after which it began to increase (see Fig. 7.2).

Fig. 7.2

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/uvo#!/cube/plkopr [Accessed on August 25, 2022])

Swiss consumer price inflation: July 1944 to July 2022

In 1974, the SNB raised the penalty rate on non-resident deposits to 3% per quarter. Upward pressure on prices eased in mid-1975, allowing the Bank to relax some of its restrictions, but a wave of speculative capital inflows in mid-1977 prompted the imposition of new ones. In early 1978, the SNB put restrictions on inflows of foreign banknotes, increased the penalty rate on non-resident Swiss franc deposits from 3% per quarter to 10% per quarter, and prohibited interest payments to foreign monetary authorities on their Swiss franc deposits. Despite these measures, between January 1973 and December 1978, the Swiss franc’s real effective exchange rate increased by 34%.⁶¹ From August 1971, when the Bretton Woods System collapsed, to December 1978, the increase was significantly above that rate (i.e., 41%).

For the first five years after the collapse of the Bretton Woods system, the SNB’s operating policies targeted the money-stock growth rate. Still, it intervened occasionally in the spot US dollar/Swiss franc market to reduce or reverse exaggerated currency fluctuations. With dramatic increases in the nation’s exchange rate, the SNB temporarily suspended, in October 1978, its policy of targeting monetary growth.⁶²

Swiss Franc—German Mark Exchange Rate: October 1978 to December 1979

An appreciating Swiss franc put the SNB on the horns of a dilemma. Reducing the value of the Swiss franc by intervening in the foreign exchange markets risked increasing the domestic money supply and fueling inflation. Still, refraining meant pricing many Swiss products out of international markets. Realizing the long-term futility of imposing penalties and other restrictions on foreign capital inflows, the SNB relaxed its restraints in 1979 and elevated exchange rate levels from their penultimate position as operating targets to a top position as policy goals. In particular, the Bank announced its intention to keep the German mark’s price significantly above 0.80 Swiss francs (i.e., keep the Swiss franc’s value significantly below 1.25 German marks). Important to note is, at the time, the SNB did not perceive this policy shift as a permanent or long-term change in strategy but rather as a necessary (and hopefully temporary) adjustment during a time of excessive market turbulence.

Due to substantial foreign currency inflows, massive intervention was needed. The resultant increase in Switzerland’s monetary base, combined with the second oil price shock, lifted Swiss inflation from 1.0% in 1978 to 3.6% in 1979 and to continuously higher levels in the early 1980s. A short break came in 1979 when the German mark traded significantly above the SNB’s floor target of CHF 0.80. This buffer allowed the Bank to reduce liquidity and swiftly return to its policy of targeting monetary aggregates. Exchange rate targets were no longer prescribed, but the SNB’s monetary policies paid close attention to their movements.

Short-Term Adjusted Monetary Base and Short-Term Money Supply Growth Rates: January 1980 to December 1990

With reduced pressure on the franc, the SNB felt justified in 1980 to re-establish a money supply target (after one had not been made for 1979) that would not endanger the exchange-rate target it had announced in October 1978. Controlling the money supply proved more complicated than expected. As a result, the SNB switched later in 1980 from its short-term money supply target to a monetary base target. Inflation rates, which averaged 5.4% from 1980 to 1982, moved progressively lower from 1983 to 1985 and fell below 1.0% in 1986 (see Fig. 7.2).

Switzerland’s M1 money supply expanded by nearly 8% between the beginning of 1985 and October 1987 (see Fig. 7.3).⁶³ One reason for this increase was the SNB’s accelerated foreign exchange market intervention, as it fought against the US dollar’s depreciation, starting in 1985.

Fig. 7.3

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbmonagg [Accessed on August 25, 2022])

Monetary aggregates: Monetary base (M0), M1 , M2 , and M3 —1984 to July 2022

In 1987, several significant events caused the SNB to overstimulate the Swiss economy and fuel inflation. For one, the SNB underestimated the impact of the SIC’s⁶⁴ introduction and changes in bank liquidity requirements on bank demand for central bank money (i.e., reserves). The result was an increase in Switzerland’s money multiplier. A second cause of the SNB’s looser-than-needed monetary policies was its overreaction to the US stock market crash in October 1987. Fearing recessionary contagion, as many central banks did, the SNB pursued monetary policies to support domestic growth and employment. Switzerland’s monetary base’s growth rate doubled from about 2% in 1986 to 4% in 1987. By mid-1988, recessionary fears had receded, and the liquidity effects of the SIC and new requirements were better understood, which left the SNB with the job of reigning back the inflationary potential of its 1987 policies.

In 1988, the SNB responded to a looming inflationary threat by curtailing the monetary base’s growth rate, leading to a dramatic rise in interest rates and an appreciation of the Swiss franc. Switzerland’s three-month interbank rate jumped from 3.2% in 1988 to 9.0% in 1990.⁶⁵ This sharp move precipitated a severe recession and led to a decline in real estate prices that lasted until 1997. The downturn was the longest in Switzerland’s post-World War II experience. Inflation fell, albeit slowly, but unemployment rose to disturbingly high levels. Interest-sensitive investment sectors were hit the hardest, such as construction, machinery, and equipment.

Medium-Term Adjusted Monetary Base: January 1991 to December 1999

Criticisms of the SNB’s laxness combined with problems gauging banks’ demand for money caused the Bank to change its operational goals in January 1991 to medium-term (i.e., three-to-five years) growth rate of the adjusted monetary base. Swiss interest rates trended downward from 1990 to 1994 (see Fig. 7.4) mainly due to reduced inflationary expectations and recession-induced decreases in spending and borrowing demand, but other factors also played significant roles. Sizable volumes of international capital flowed to Switzerland during 1992 due to turmoil surrounding England and Italy’s exit from the European Exchange Rate Mechanism. These inflows were reinforced by fears following the terrorist attacks in New York City in 1993 and the Mexican Tequila Crisis in 1994. Furthermore, Switzerland’s strong current account balance and reductions in German interest rates helped to stabilize Swiss interest rates at lower, more normal levels.

Fig. 7.4

(Source Organization for Economic Co-operation and Development, Long-Term Government Bond Yields: 10-year: Main (Including Benchmark) for Switzerland [IRLTLT01CHM156N], retrieved from FRED, Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/IRLTLT01CHM156N, [Accessed on August 24, 2022]. Organization for Economic Co-operation and Development, 3-Month London Interbank Offered Rate [Libor], based on Swiss Franc [IR3TIB01CHM156N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/IR3TIB01CHM156N, [Accessed on August 24, 2022])

Short-term and long-term Swiss interest rates: 1989 to June 2022

Switzerland’s 1991 recession confronted the SNB with a quandary. Unemployment rates increased much above acceptable levels and averaged nearly 8% for the year, but the SNB was not convinced that inflationary fears had been fully extinguished. Bank officials worried that monetary stimulation would reduce Switzerland’s real interest rates even further below their German counterparts, resulting in a shift of financial capital that would lower the Swiss franc’s value and exacerbate domestic inflation.

When the Swiss recovery began during the second quarter of 1993, it was not strong enough to raise GDP for the entire year, and sluggish growth was expected to persist well into 1996. In general, there were problems on several levels. Spending lacked a broad base because consumption was weak due to a general lack of household confidence, and public expenditures were tepid due to budget deficit concerns. Only export orders were robust. Furthermore, monetary policy remained cautiously passive, and Switzerland lost momentum on structural changes in public policy, such as the consolidation of public finances and various social policy programs and the removal of domestic and international barriers to market access.

Because of the combined effects of Switzerland’s lackluster economic growth, the Swiss franc’s strength, and an unemployment rate that had increased from 5.8% in 1995 to 6.9% in 1996, businesses and unions put the SNB under considerable pressure to refuel money supply growth. They argued that the Swiss economy was fully able to handle more liquidity without a resurgence of inflation. The yield curve turned moderately positive, but the growth of Switzerland’s monetary base remained below targeted levels, causing inflationary fears to recede. There was every reason to believe the SNB would continue its conservative monetary stance,⁶⁶ generating a premium on its caution. In short, the Bank did not want to repeat mistakes of the 1980s by raising domestic inflation and refueling the country’s ever-more intransigent inflationary expectations.

Despite its success at keeping the average inflation rate at 2.8% from 1975 to 2000, the strategy of using monetary aggregates as intermediate policy indicators became problematic and was openly criticized during the second half of the 1990s. Success from using monetary indicators as operating targets depends on three factors. First, it requires a clear correlation between the nation’s money supply and inflation, and this relationship depends on a stable demand for the monetary aggregates used as intermediate monetary targets. Unfortunately, this relationship no longer held for Switzerland’s monetary base, perhaps, due to the unstable money demand caused by innovations in the financial sector and payment systems.

Second, the central bank needs almost complete control over the targeted monetary aggregates to reach the inflation targets. Monetary aggregates, such as M1 or M2, are challenging to control due to influences beyond a central bank’s monetary policy.

Finally, the monetary aggregate must be relatively insensitive to interest rate fluctuations. Ultra-high interest elasticity and an unstable demand for money impair the stabilizing effects of monetary policy on the real economy. If the correlation between inflation and money supply growth is low, monetary policies become error-prone, and communication with the public becomes difficult. As a result, monetary policies can have undesired effects on inflationary expectations.

The euro’s introduction in 1999 caused (and is continuing to cause) uncertainty in Switzerland because significant fluctuations in its value could open and close trade and investment opportunities. Any perceived weaknesses and lost confidences in the euro’s management were sure to drive short-term capital toward safe havens, like Switzerland. At the same time, the euro’s introduction presented Switzerland with a counter-threat that the euro might marginalize the Swiss franc in international markets. With economic power comparable to the US dollar, the euro could have prompted massive capital outflows into the euro, causing the Swiss franc to plummet in value.

Initial concerns that the euro might cause an excessive appreciation or depreciation of the franc were justified but, in retrospect, overstated, as the franc held steady against the euro from the beginning of 1999 to early 2000. This stability led some to believe the SNB was intervening to maintain an informal exchange rate band around the euro, but they were soon disabused of this notion. Perceiving an atmosphere of more robust economic growth, in 1999, the SNB contracted monetary growth rates to keep inflation near its 2% goal. The SNB’s changed focus meant the Swiss franc would be allowed to fluctuate (presumably) with less regard for any particular monetary target rate or range. The exchange rate was still considered an essential monetary tool but mainly for its effect on inflation.

Three-Month Libor: January 2000 to September 2011

Starting in 2000 and continuing to 2021, the SNB’s strategy for executing monetary policies has focused on three factors:

• 1. Defining price stability,

• 2. Making conditional long-term inflation forecasts, and

• 3. Setting its “policy” interest rate.

The Bank’s “Conditional Inflation Forecasts,” reported in the Quarterly Bulletin, are used on an ongoing basis to adjust the SNB’s policy rate and money market liquidity. The SNB has used this publication to communicate its inflation rate expectations to the public. In addition, transparency has been accomplished through the weekly releases of monetary policy data.

The SNB defined its price stability target in terms of the Consumer Price Index (CPI), and its new goal was similar to the past, with the desired inflation range staying between 0.0 and 2.0%. Fig. 7.2 shows Switzerland’s CPI-based inflation rates from 2000 to June 2022. Under the SNB policy, continuous adherence to the inflation rate target was unnecessary so long as its medium-term target was not jeopardized. In doing so, the SNB acknowledged that short-term deviations could occur from time to time due to serendipitous demand- and supply-side fluctuations, such as unexpected exchange rate changes and oil price shocks.

The second monetary policy prong centered on quarterly conditional inflation forecasts, which served as the focal indicators for the SNB’s interest rate decisions. They were conditional because projections were based on assumptions that the short-term rate (i.e., three-month Libor) and world economic conditions would stay constant over three years and not trigger monetary policy reactions. Three-year forecasts were chosen because this extended period gave the Bank’s monetary policies the transmission time needed to take effect. The SNB never reacted mechanically to these inflation forecasts, so this method allowed it to evaluate whether current interest rates were compatible with medium-term price stability in the context of evolving domestic and international economic and monetary conditions. Based on these forecasts, the SNB reviewed and, if necessary, adjusted its monetary policies.

An inflation forecast was published every quarter and became an essential public communication tool for the SNB. For example, if the three-year inflation forecast exceeded the 2.0% limit, the likelihood of the SNB raising interest rates during the projection period increased. By contrast, the threat of deflation prompted the Bank to increase liquidity. Targeting medium-term inflation allowed the Bank to address short-term turmoil only when it posed a potential threat to longer-term price stability.

The final prong of the SNB’s new monetary concept was setting an operational goal for its short-term “policy rate,” which varied with current and projected economic conditions and whose range of fluctuation was usually about 1.0 percentage point. The Bank announced whether it wished the rate to be at or near the low, medium, or high portion of the targeted range. Figure 7.5 shows the evolution of the SNB’s targeted policy-rate range. Between January 2000 and June 2019, the Bank targeted the three-month Libor.⁶⁷

Fig. 7.5

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbband [Accessed on August 25, 2022]; Organization for Economic Co-operation and Development, 3-Month London Interbank Offered Rate [Libor ], based on Swiss Franc [IR3TIB01CHM156N], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/IR3TIB01CHM156N, [Accessed on August 25, 2022])

The SNB’s targeted three-month policy rate limits: January 2000 to December 2021

The SNB’s new monetary concept allowed it to make monetary policy decisions more systematically and balanced, based on broader and deeper market information. Due to the target range’s width and initial three-month target rate, the SNB gained greater flexibility in responding to financial market disruptions. Fortunately, the new strategy was successful. From 2000 to September 2011, the SNB managed to keep the average inflation at 0.90% (see Fig. 7.2).

The SNB’s restrictive monetary policies relative to its European neighbors caused the franc to appreciate after 2000 and soon raised concerns about how long the Bank could deemphasize exchange rate movements. From EUR 0.62/CHF in early 2000 to a high of almost EUR 0.69/CHF in May 2002 (more than an 11% increase), the Swiss franc appreciated at a rate that caught many off guard. Part of the problem was likely due to the “unknown unknowns” connected to the newly formed Euro Area and lack of familiar performance measures.

Contractionary Monetary Policy: 2000 to 2001

Due to growing inflationary fears, in 2000, the SNB progressively tightened monetary policy by raising its Swiss-franc Libor target. In this one year, it increased Libor from a range of 1.25‒2.25% to 3.00‒4.00%, while targeting the middle of this range.

Expansionary Monetary Policy: 2001 to 2004

Feeling that inflation was under control but fearing the short-term rate increases might spark an undesired appreciation of the Swiss franc, the SNB spent 2001 lowering the targeted Libor range. The rationale for pursuing looser monetary policies was consistent with the SNB’s reaction to a stock market decline in spring and summer 2001 and the unpredictable impact that the 9/11 terrorist attacks in the United States might have on the world economy. Expansionary monetary policies throughout 2001 brought the SNB’s target rate range to 1.25‒2.25% by year’s end, which was a combined one-year decrease of 1.75%.

In 2002, the SNB continued reducing the three-month Libor. Slow domestic growth, an appreciating Swiss franc, and sluggish economic activity among Switzerland’s major trading partners prompted this defensive action. In May 2002, the Bank reduced its operating target by 0.5% to 0.75‒1.75%, and in July, it lowered the rate again by 0.5 to 0.25‒1.25%, which is where the target ended the year. Fears of recession intensified in 2003 with the outbreak of war in Iraq, causing the SNB to lower and narrow its target range to 0.0‒0.75% and announce its intention to keep Libor at the lower end of this narrower range.

Contractionary Monetary Policy: 2004 to 2008

From 2004 to mid-2008, the SNB fine-tuned and tightened its monetary policies. In June 2004, the Bank re-established the broader 1.0% Libor range and set its sight on adjusting Libor to the middle of the target range of 0.0‒1.0%. The range had already increased to 0.25‒1.25% by year’s end. Throughout 2006 and 2007, the SNB aggressively increased its Libor target by a series of 0.25% adjustments so that, by September 2007, the target range stood at 2.25‒3.25%, which was a full 2.0% increase in just two years. Between 2004 and 2007, the Swiss franc fell against the euro, reaching a low of slightly less than EUR 0.60/CHF in October 2007. Still, from then until late 2011, its value appreciated substantially, in large part, due to the global economic and financial crisis and, after that, the European debt crisis.

Monetary Policy During the Financial Crisis: 2008 to 2009

During the summer of 2007, declining U.S. real estate prices caused banks (virtually worldwide) to suffer mounting losses on their purchases of U.S. mortgage-backed securities. Write-offs became unavoidable, and banks began hoarding liquidity due to the loss of confidence in the financial industry. In August 2007, liquidity in the U.S. interbank market dried up, causing a widespread loss of confidence among banks. Aggressive monetary measures were needed to rebuild financial trust, resist an economic downturn, and avoid deflation, but conditions worsened. December 2007 marked the official start of the U.S.’s “Great Recession,” which spread rapidly to other countries.

During 2008, the global financial system was gradually engulfed by this downward economic and financial spiral. The U.S. government reacted by passing economic stimulus and stabilization bills, acquiring the shares of threatened financial institutions and companies, lending to endangered firms, providing subsidies and tax breaks to individuals and companies, and expanding social welfare programs and unemployment compensation. By September 2008, the world financial system seemed to be on the brink of collapse, signaling the need for many countries to pursue expansionary fiscal and monetary measures to rescue their nations from economic peril. These governments responded with many of the same fiscal measures used in the United States. Central banks reacted by purchasing illiquid assets to unburden bank balance sheets, increasing guarantees on savings accounts, and taking equity stakes in financial institutions considered crucial for the functioning of the entire financial system.

Switzerland’s monetary reaction to the economic and financial crisis began in August 2007 and took on a strong international flavor in October 2008, when the SNB and five other major central banks made a joint statement announcing their intention to lower interest rates.⁶⁸ Figure 7.3 shows the sharp increase in Switzerland’s monetary aggregates, as the Bank took active measures to increase the monetary base and money supply . The SNB immediately reduced its policy rate range by 0.25%, followed by two decreases in November, amounting to 1.5%, and a 0.5% decrease in December 2008—so that its policy rate range dropped to 0.0‒1.0%. The range narrowed to 0.0‒0.75% in March 2009, with the SNB targeting the lower portion at about 0.25%.

Figure 7.4 shows the sharp 2.6% drop in the Swiss franc three-month Libor between October 2008 and April 2009, commensurate with an exceptionally steep increase in Switzerland’s monetary aggregates (see Fig. 7.2). With prices now falling, the threat of inflation had receded, causing the SNB to feel justified by its assertive behavior.

Monetary Policy During the Sovereign Debt Crisis: 2008 to 2011

Europe’s sovereign debt crisis began in 2008 when Iceland’s banking system imploded, and it spread rapidly to Portugal, Italy, Ireland, Greece, Spain, and Cyprus during 2009. Greece was bailed out in May 2010, followed by Ireland (November 2010), Portugal (May 2011), Spain (June 2012), and Cyprus (June 2012). Two significant causes of the debt crises were the Great Recession and refinancing difficulties linked to sovereign nations’ credit rating reductions. By late 2008, worldwide efforts by central banks to reduce interest rates and stimulate their economies caused nominal interest rates to plummet. Figure 7.4 shows the sharp increase in Switzerland’s monetary aggregates, as the SNB provided liquidity to the market. Its actions were successful, derailing the threat of deflation and slowing economic growth.⁶⁹ Because interest rates were already close to zero, the Bank used three unconventional measures to stabilize the financial system and stimulate the economy, namely to:

• Increase the maturity volume of repo transactions and foreign-exchange swaps;

• Purchase Swiss-franc-denominated bonds issued by private sector companies and SNB Bills, and

• Buy foreign currency on the open market to prevent further appreciation of the Swiss franc.⁷⁰

Balanced monetary policies were necessary, so the SNB used a blend of tools that had both a permanent and temporary nature. Purchasing foreign exchange and Swiss franc bonds can be viewed as a one-way (i.e., permanent) increase in the monetary base. By contrast, the liquidity created by repos and currency swaps is a temporary, two-way flow because any expansion is reset at maturity. By the end of 2009, the SNB concluded that the nation’s recovery was fragile and uncertain, but the threat of deflation had receded based on its conditional inflation forecasts. By mid-April 2010, escalation of the sovereign debt crises prompted widespread capital flight from tottering European nations’ currencies to the Swiss franc, causing the Bank to make a renewed round of large-scale foreign exchange purchases to prevent a rapid appreciation of the Swiss franc. The resulting increase in Switzerland’s monetary base might be viewed as Switzerland’s version of “quantitative easing.”

Volatility in the financial markets declined substantially by 2010 because of the newly introduced European Financial Stability Facility, established by the European Union (EU), European Central Bank (ECB), and the IMF. In June 2010, the SNB decided that a further appreciation of the Swiss franc no longer posed the same threat to price stability, so it terminated its foreign exchange interventions. This absence from the currency markets was short-lived.

Summer 2010 brought a bevy of financial problems for the SNB. The sovereign debt crisis in Greece and emerging debt problems of other EU member states, such as Ireland, Portugal, Spain, and Italy, combined with a politically induced U.S. debt crisis, intensified capital flight to the Swiss currency and led to a massive depreciation of the euro and the U.S. dollar against the Swiss franc. Continued appreciation of the Swiss franc posed potentially serious problems for the export-oriented sectors of the Swiss economy. Of particular interest to Switzerland was the franc’s relationship to the euro because nations in the Euro Area were its largest trading partners. In 2010, total Swiss imports from Euro-Area nations were nearly 13 times higher than from the United States, and exports to the Euro-Area were almost five times higher than to the United States.⁷¹

In 2010, the SNB’s official reserves rose by CHF 113 billion, to CHF 252 billion, mainly due to CHF 108 billion worth of foreign currency purchases, which were intended to reduce the Swiss franc’s value.⁷² The intervention resulted in considerable book losses for the SNB, amounting to CHF 26.5 billion (i.e., −10.1%) on its new and existing foreign exchange reserves.⁷³ In the face of strong public criticism for these losses, the SNB’s distribution reserve turned negative, amounting to CHF −5 billion at the end of 2010 and causing a significant decline in the Bank’s equity-to-asset ratio. Even though the SNB was one of the most highly capitalized central banks globally, losses of this dimension could quickly deplete the Bank’s equity. Between October 2007 and August 2011, the Swiss franc appreciated nearly 50% against the euro to EUR 0.89/CHF. An appreciation of this scale threatened the Swiss economy with job losses and, equally important, deflation, which would have increased burdens on Swiss-franc debtors and forced unwelcomed internal adjustments.

Swiss Franc—Euro Exchange Rate: September 2011 to January 2015

In August 2011, the Bank lowered its Libor target range to 0.0‒0.25%, where it remained until January 2015. To guard against disruptive appreciations of the Swiss franc, which might threaten its price stability goals, the SNB decided, in September 2011, to set a minimum exchange rate of 1.20 Swiss francs for one euro (i.e., a maximum price of 0.83 euros per Swiss franc).⁷⁴

By choosing to hitch the Swiss franc to the euro in 2011, the SNB relinquished considerable control over the nation’s money supply growth but sent a clear signal to the markets that it would not throw Switzerland’s export sector under the tires of runaway international capital markets—regardless of how large they were. With more than US$4 trillion in total daily global foreign exchange transactions,⁷⁵ there was serious concern that the SNB would be unable to enforce its new ceiling if the massive potential volume of international capital flows came into play. At least for the short term, the SNB’s policy went hand-in-glove with its priority of preventing deflation. By imposing a ceiling on the Swiss franc’s value in euros, the nation’s monetary base skyrocketed, causing consternation among some market analysts that it portended inflationary pressures in the future.

One of the most worrying threats to the SNB’s new policy of capping the Swiss franc’s value relative to the euro was the rapid and significant increase in foreign currency exposures. If the Bank was correct and the Swiss franc was (indeed) overvalued, then the euros it purchased should appreciate, earning it significant currency gains in the future. Conversely, if the SNB’s expectations proved inaccurate and the Swiss franc continued to appreciate, book losses amounting to billions of Swiss francs could result. The stakes associated with policy mistakes were prominent and visible, while the benefits associated with successful policy interventions were widely distributed and less evident.

Figure 7.6 provides a striking visual portrayal of the significant growth in Switzerland’s monetary base and the SNB’s official reserves after 2008, as well as the dramatic reduction in three-month Libor below zero.

Fig. 7.6

(Source SNB, SNB Data Portal, https://data.snb.ch/en [Accessed on August 24, 2022])

SNB official reserves, Switzerland’s monetary base, and Swiss three-month Libor: January 2008 to June 2022

The SNB’s policy of capping the Swiss franc at 0.83 euros and targeting three-month Libor at 0% survived 2011, but official reserves rose during the year by 22% (see Fig. 7.6). In the first quarter of 2012, the exchange rate limit was breached, causing the SNB to pursue an aggressive intervention strategy, which raised its official reserves by 67% for the year (see Fig. 7.6).

The SNB kept its options open about how long the policy would continue. Pressure came from exporters, who argued for an even weaker franc, moving it from EUR 0.83/CHF to EUR 0.80/CHF or, perhaps, EUR 0.77/CHF (i.e., from CHF 1.20/EUR to CHF 1.25/EUR or CHF 1.30/EUR), but the SNB judged the costs of doing so were problematic. A weaker Swiss franc was perceived as having only marginal benefits for exporters but imposing considerable burdens on the SNB—not only in terms of potential market attacks on the Swiss franc but also international accusations of currency manipulation. The Swiss franc’s strength reflected a weak Eurocurrency Zone rather than a solid and vibrant Swiss economy.

Swiss GDP was vulnerable and projected to grow at tepid rates well into 2012 due to the Eurozone debt crisis, weak external demand, and lackluster business confidence. During the previous 12 years, the Swiss franc had shown considerable volatility against the euro, which was also why the Swiss currency was still highly demanded for diversification purposes.

The SNB’s credibility and unconditional enforcement of the 1.20 floor showed signs of success in 2013 when appreciation pressures abated. Without the need to intervene, official reserves fell by 2% in 2013 and increased by only 1% during the first five months of 2014. Inflation seemed under control, and economic growth showed real signs of life.

Negative Interest Rates

During 2014, continued financial, economic, and sovereign-debt problems in Greece were exacerbated by the Ukraine conflict, growing concerns about Europe’s economic weakness, political uncertainty, and sluggish growth prospects for China—all of which increased the demand for the Swiss franc. The SNB reacted by lowering its target Libor into the negative range, from 0.0‒0.25 to –0.75‒0.25%. Continued upward pressure on the Swiss franc was relentless, prompting the SNB, in December 2014, to impose a negative interest rate equal to –0.25% on bank sight deposits at the SNB.⁷⁶ In part, this change was in reaction to a similar policy by the European Central Bank .

In January 2015, the SNB reduced the sight deposit rate to − 0.75% and changed the target range for three-month Libor to − 1.25‒ −0.25%.⁷⁷ The policy of negative interest rates led some economists to argue that the SNB had maneuvered itself into a liquidity trap,⁷⁸ while other economists warned of the long-term dangers that excessive monetary stimuli applied over long periods could cause. In the foreign exchange markets, the results were clear. From May to December 2014, the SNB’s official reserves increased by 11%.

The Swiss Franc-Eurocurrency Peg is Abandoned, but Exchange Rate Targeting Continues

The battle to fix Switzerland’s exchange rate at 0.83 euro per Swiss franc was fought until January 2015, when the SNB abandoned this target but stated its intention to remain active in the foreign exchange markets. Continued efforts to peg the Swiss franc to the euro were considered “no longer justified from a monetary policy point of view”⁷⁹ by the SNB after the euro depreciated against the U.S. dollar, with the Swiss franc following in step. As a result, the Swiss franc’s trade-weighted value eased somewhat, giving the SNB a bit of breathing space.

A second factor in the SNB’s decision to abandon its euro peg may have been the Euro Area’s sluggish growth rate compared to other developed nations, such as the United States. The SNB’s decision to end the currency peg freed the franc from a struggling counterpart.

Another reason for abandoning the fixed-exchange-rate commitment was that the SNB had accumulated massive amounts of euros during slightly more than three years, significantly enlarging its balance sheet and currency risk exposures. As its euro-denominated assets depreciated, the SNB’s reported profits and equity were affected negatively. The SNB’s equity fell so low that questions were raised about whether it might become insolvent.

SNB Chairman Thomas Jordan tried to diffuse concerns by reminding the public that “Even though it is in a position of short-term negative equity, a central bank retains full capacity to act because it cannot become illiquid. Even with a negative equity position, legal measures do not need to be taken, in contrast to the situation for a private company.” He went on to say, “However, in the long term, a sustained state of negative equity may undermine a central bank’s credibility and independence. It is therefore vital that the SNB rebuild its equity as soon as possible after losses have been sustained, and that it maintains a strong balance sheet in the long term.”⁸⁰

Three-Month Libor, SNB Sight Deposit Rate, and Exchange Rate Situation: January 2015 to June 2019

After abandoning the exchange-rate cap on the Swiss franc, the SNB’s monetary policy target became a combination of the three-month Libor, the interest rate charged on bank sight deposits at the central bank, and exchange rate conditions. Targeting these financial indicators became a bit easier as the European debt crisis subsided and economic conditions in Switzerland returned closer to normal.

Britain’s decision to exit the EU in June 2016 (i.e., Brexit) added uncertainty to the market until it was finalized on January 31, 2020. The unanswered question was, “If Britain left, would others follow?” The resulting “flight to safety” put temporary upward pressure on the Swiss franc, shocked global stock markets, and added pressure on countries like Italy, which were also struggling with sovereign debt issues. Similar pressure, albeit relatively lighter, emerged between 2018 and 2021, with Turkey’s and Argentina’s currency, debt, and political crises.

SNB “Policy Rate”: June 2019 to July 2022

In 2017, Switzerland’s Financial Conduct Authority announced its intention to drop Libor as a reference rate by 2021. Of the possible replacements, the SNB’s Working Group on CHF Reference Rates considered the Swiss Average Rate Overnight, more commonly known by its abbreviation “SARON,” to be the most representative short-term money market rate. In June 2019, the SNB introduced SARON as its official “Policy Rate” and shifted the Bank’s target toward a reference rate and away from the three-month Libor reference range. The SNB planned to keep the new policy rate and bank sight deposit rates at −0.75%.⁸¹ FINMA and the SIX Swiss Exchange reacted by closely monitoring developments and informally encouraging and supporting banks’ preparation for SARON , which is based on concluded short-term repo transactions and representative quotes. Because market participants typically engage in longer-term contracts (e.g., loans and mortgages ), SARON Compound Rates and Indices have been provided by the SIX since March 2020.⁸²

With an eye on ensuring Switzerland did not fall into a recession, from June 2019 to March 2022, the SNB kept its sight deposit and SARON rates at − 0.75%. At the same time, it expressed an open willingness to intervene in the foreign exchange markets to counteract foreign interest in Swiss financial assets that might induce an unwanted appreciation of the Swiss franc. In March 2020, the Bank increased its threshold factor from 25 to 30, providing relief to Swiss banks trying to remain profitable in a shallow interest rate environment.⁸³

In March 2020, the SNB, Bank of Canada, Bank of England, Bank of Japan, European Central Bank, and Federal Reserve announced a joint action to enhance the availability of U.S. dollar liquidity via their standing swap line arrangements.⁸⁴ The policies were effective, and due to the sustained improvements in U.S. dollar funding conditions, on July 1, 2021, the non-U.S. banks, in consultation with the US Federal Reserve , decided to discontinue offering dollar liquidity with an 84-day maturity and returned to the normal seven-day maturity .

The SNB and COVID-19 Pandemic (2020–2022)

In February 2020, the coronavirus disease (COVID-19) spread rapidly worldwide and plunged Switzerland into a recession. The virus upped the stakes for the SNB’s monetary policies. While keeping both the interest rate on bank sight deposits and the SNB policy rate at − 0.75%, the Bank tried to ease the burden on domestic banks by increasing the threshold on sight deposits not subject to the negative interest rate from CHF 25 million to CHF 30 million, starting April 1, 2020, and reducing the countercyclical capital buffer to 0%, effective immediately.⁸⁵

To cushion the effects of the COVID-19 pandemic, in March 2020, a consortium composed of the Swiss Confederation, SNB, FINMA, and domestic Swiss banks launched a package of new liquidity measures. Part of this initiative was a temporary standing facility, called the SNB COVID-19 Refinancing Facility (CRF). Intentionally, it was created as a liberal source of funds for banks, without upper loan limits, free of access and maturity restrictions, and carrying an interest cost equal to the SNB policy rate. The SNB retained the daily right to increase or decrease these loans and terminate them after a three-month notice. The loans were collateralized and available to banks domiciled in Switzerland and the Principality of Liechtenstein, and some qualified Swiss branches of foreign banks, so long as these banks were connected to the SIC system. The associated claims were assigned to the SNB.

Figure 7.7 shows that Switzerland’s monetary and fiscal reactions to COVID-19 were generally successful. From the recession’s depths in the second quarter of 2020, Switzerland grew strongly in the year’s third quarter but fell to relatively tepid rates after that. Switzerland’s performance mirrored other developed countries, such as the United States and Euro Area.

Fig. 7.7

(Source FRED, Federal Reserve Bank of St. Louis; Switzerland, https://fred.stlouisfed.org/series/CLVMNACSAB1GQCH [was available only until Q1 2022]; Euro Area, , United States, [Accessed on August 22, 2022])

Quarterly growth of real GDP for Switzerland, the United States, and Euro Area: Q1 2020 to Q2 2022

At first, eligible collateral for this facility included corporate loans connected to the COVID-19 pandemic that the Swiss Confederation guaranteed. In May 2020, about two months later, eligible collateral was expanded to include canton-guaranteed loans and credit default swaps, as well as collateral having joint federal-cantonal guarantees.⁸⁶

The COVID-19 pandemic adversely affected UBS and Credit Suisse, Switzerland’s two internationally competitive, big banks, but these financial intermediaries were subject to Switzerland’s “Too Big to Fail” capital requirements (explained below), which kept their equity at relatively healthy levels. As for domestically focused Swiss banks, the pandemic did not materially affect their profitability in 2020 and 2021. Credit losses remained relatively low due to public support measures. Moreover, the mortgage and real estate markets were vibrant, and the decline in interest-rate margins slowed, allowing domestic banks to maintain or increase their capital bases.⁸⁷

SNB Policies Tighten: March 2022–June 2022

Russia’s invasion of Ukraine in February 2022 increased volatility for global supply chains and financial markets. The resulting disruptions convinced the SNB to continue supporting the Swiss economy via monetary expansion and exchange rate protection. In the following months, the nation was hit by two inflationary forces. Supply chain disruptions caused cost-push inflation, and expansionary fiscal and monetary policies worldwide (not just in Switzerland) caused demand-pull inflation. The combination convinced the SNB to dampen demand.⁸⁸ With the increase in Swiss and global inflation , it was clear that future efforts to combat inflation could be problematic unless prices were harnessed at an early stage.

Switzerland’s Inflation and Money Supply Growth Rates: 2008 to 2022

One of the singularly most interesting economic developments from 2008 to the first quarter of 2022 was the absence of accelerated Swiss inflation in the face of dramatic increases in the nation’s money supply. From January 2008 to January 2021, Switzerland’s M1, M2, and M3 money supplies increased by 176, 139, and 79%, respectively, while real GDP increased by only 18%.⁸⁹ From beginning to end, the nation’s consumer price index was virtually unchanged. The SNB’s foreign exchange purchases caused a significant expansion of Switzerland’s money supply , but the excess liquidity appears to have remained in the financial sector with no meaningful short-term effect on Switzerland’s real economy.

Too Big to Fail and the Swiss Finish

The 2009 Basel III Accord raised global minimum capital and liquidity guidelines on the quantity and quality of bank capital, but it did not go far enough. For example, unaddressed was the too-big-to-fail problem, which was (and has been) particularly pronounced in Switzerland because of the two big banks’ (i.e., UBS and Credit Suisse) enormous size relative to the Swiss economy (e.g., gross domestic product). A failure of one (or both) could pose an existential threat to the Swiss financial system and its economy. The Federal Council responded to this potential threat by appointing a commission of experts to examine the “too-big-to-fail” problem. In October 2010, the Commission presented its final report with recommendations.⁹⁰

The proposals went beyond minimum international standards, particularly for capital and liquidity requirements, by imposing stricter capital requirements on the big banks relative to small- and medium-sized Swiss banks. The heightened level of supervision and restriction is often called the Swiss finish and earned Switzerland the distinction of being a world leader in capital requirements.

Banks deemed “too-big-to-fail” were required to hold at least 10% of their risk-weighted assets in the form of common equity—the strictest form of capital. In addition, they needed to maintain an additional 9.0% buffer, which could be in the form of contingent convertible bonds.⁹¹ These bonds could be converted into equity when their core capital ratio fell below a certain level, increasing potential capital requirements to 19% of risk-weighted assets .

The new capital standards had three tiers. Like Basel III, the first was an initial minimum requirement for common equity of 4.5%. The second was a mandatory buffer of 8.5%, of which a minimum of 5.5% had to be held in the form of common equity. Finally, a progressive capital component in contingent convertible bonds (i.e., cocos) was initially set at 6%, with a common-equity trigger of 5%,⁹² which rose or fell depending on a bank’s size, market position, and interconnectedness.⁹³ Furthermore, the Commission recommended that organizational measures be taken to ensure the continuation of systemically relevant functions (e.g., lending business and executing payment systems ) during a crisis while simultaneously liquidating the bank in an orderly manner.⁹⁴

The StabFund for UBS Assets

Due to severe market turbulence during fall 2008, UBS lost considerable amounts on its U.S. and European mortgage and leveraged-finance positions. Unable to increase its equity in the private markets, a government or central bank bailout was considered the only solution. Fearing the worst, a plan to rescue UBS and the Swiss financial system was adopted by the Federal Council, the Swiss Federal Banking Commission (now FINMA), and the SNB. Its design was based on two measures.⁹⁵ First, to restructure and improve the health of UBS’s balance sheet, the Swiss government purchased CHF 6 billion of UBS’s newly issued mandatory convertible securities (MCS), thereby strengthening the bank’s capital base.⁹⁶ Second, UBS transferred a portfolio of illiquid securities to a newly established special purpose vehicle, called the SNB StabFund Limited Partnership for Collective Investment (aka, the “StabFund”), which was responsible for the orderly liquidation of UBS’s “bad” assets.⁹⁷

The StabFund was created in October 2008 as a limited partnership. Of the US$60 billion allotted for the bailout, only US$38.7 billion was effectively transferred to the “bad bank” portfolio.⁹⁸ By April 2009, the bad assets had been completely transferred . Because US$8.8 billion of the fund’s value was in derivatives (i.e., contingent liabilities ) and $3.9 billion was covered by UBS , the SNB needed to finance only about $25.8 billion for the assets and contingent liabilities .⁹⁹

A prominent feature of the bailout was UBS’s call option to repurchase its assets at a strike price of US$1 billion plus 50% of the portfolio’s net asset value over US$1 billion.¹⁰⁰ This option was contingent on the SNB loan being fully amortized at the time of repurchase. The agreement also stipulated that, if the loan were not fully repaid, the SNB had the option to acquire 100 million UBS shares at the par value of CHF 0.10 per share .

Looking back, the Swiss government made a financially attractive deal by engaging in this transaction because it was able to sell its UBS-issued MCS tranche, in August 2009, for CHF 5.48 billion and earned interest payments of CHF 1.8 billion for the period of its participation. In total, the government made a profit of roughly CHF 1.2 billion.

The SNB’s efforts were also a financial success, with UBS returning to profitability in the fourth quarter of 2009 and Switzerland’s economic activity rising. In November 2013, UBS paid the SNB US$ 3.8 billion (CHF 3.44 billion) for its portion of the StabFund’s equity, and in August 2013, the loan was fully repaid. Together with an additional US$1.6 billion in interest payments, the SNB earned a total return of US$ 5.4 billion from the bailout.¹⁰¹

Structure of the SNB’s Assets : 2000 to 2022

Like many developing nations’ central banks, the SNB’s balance sheet snowballed between 2007 and 2022 to offset the contractionary impacts of the U.S. Great Recession, European debt crises, and global Covid-19 pandemic. These asset purchases infused liquidity into struggling domestic markets. Figure 7.8 shows that from the beginning of January 2008 to June 2022, the SNB’s assets rose by more than 747%, from CHF 117 billion to around CHF 1 trillion.¹⁰²

Fig. 7.8

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbbipo [Accessed on August 25, 2022])

Growth in SNB assets, liabilities, and provisions & equity: January 1, 2000–June 30, 2022

As Fig. 7.9 shows, these expansionary monetary policies dramatically transformed the asset composition of the SNB’s balance sheet. From January 2000 to June 2022, foreign currency investments grew by nearly 1,770% and averaged more than 90% from the end of 2013 to 2022.

Fig. 7.9

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbbipo [Accessed on August 25, 2022])

Annual growth rate of SNB assets: January 2000 to June 2022

Figure 7.9 also shows how Switzerland’s gold reserves, Swiss franc securities, Swiss franc repo transactions, and U.S. dollar repo transactions were marginalized as a percent of total assets. Because the SNB’s policy has been to leave its foreign currency reserves unhedged, the Bank’s vulnerability to exchange rate fluctuations is substantial.

Provisions for Currency Reserves

The SNB does not hedge its foreign exchange risks but relies on currency diversification to manage them. A significant downside risk is the possibility of currency fluctuations causing significant fluctuations in its reported profits and valuation changes in the balance sheet because these provisions are stated at market value. For this reason, the Bank makes annual allocations from net profits to “Provisions for Currency Reserves.” The SNB has chosen this strategy because hedging the currency risk would lead to an appreciation of the Swiss franc and counter the SNB’s measures on the foreign exchange market, thereby causing unwanted changes in monetary policy, which might sacrifice financial stability for profit-taking. Annual currency provisions have a mandated minimum, which means they are allocated regardless of whether yearly profits are positive or sufficient. Therefore, provisions above net profits reduce retained earnings (i.e., the Distribution Reserve). The mandated currency provisions help ensure that adequate funds will be available if the SNB needs to defend an unwelcome Swiss franc depreciation.

Before 2009, Provisions for Currency Reserves were based on Switzerland’s average annual growth rate for nominal GDP during the previous five years. Due to the financial and economic turmoil in the early 2000s, this allocation was changed, between 2009 and 2016, to two times the previous five-year annual growth rate in nominal GDP. Since 2016, the minimum yearly distribution has been changed to 8% of the currency provisions balance at the end of the previous year.

As Fig. 7.10 shows, the SNB’s stunning increase in assets was accompanied by an equally dramatic reduction in its equity-to-assets ratio. The NBA fixes the Bank’s share capital at CHF 25 million, so the overwhelming majority of its equity is composed of provisions for currency reserves and retained earnings (called “Distribution Reserve”). As noted above, every year, a portion of the Bank’s net profits are allocated to currency provisions, which act as a reservoir of liquidity to support foreign exchange market intervention and cushion against financial risks. Because annual allocations to currency provisions are mandated, dividend distributions may be withheld, and retained earnings may be negative, as they were in 2013.

Fig. 7.10

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbbipo [Accessed on August 25, 2022])

SNB equity as a percent of assets: January 2000 to June 2022

From January 2000 to August 2008, the SNB’s asset-to-equity ratio averaged 54% but trended dramatically downward after that. From 45% in August 2008, the SNB’s equity ratio fell to 12% in September 2011, when the SNB began to peg the Swiss franc to the euro. The peg seemed to help temporarily, but in January 2015, when the peg ended, the SNB’s equity-to-asset ratio had fallen to a paltry 6%.

Could the SNB Become Insolvent?

From 2011 to 2016, the SNB’s equity-to-asset ratio fell so low that concerns were raised as to whether the Bank might become insolvent—and, if so, then what?¹⁰³ A central bank can become insolvent if the values of its assets are less than liabilities and equity is negative. Solvency is different from liquidity, and to remain sustainable, the SNB needs liquidity to pay its bills. This ability would not be threatened by insolvency because the Bank has the constitutional power to create monetary base to pay for assets and meet its financial obligations. At the same time, the Bank’s long-term credibility and political independence could be threatened if it could not remain solvent.

The SNB’s Gold Holdings

From the 1920s to 1997, Swiss franc banknotes had 40% gold backing. In 1997, this requirement was reduced to 25%, and in 2000, it was abandoned. As one of a few currencies in the world with gold backing, the cost of keeping the Swiss franc tied to this precious metal became increasingly evident. The SNB’s official price of gold was considerably below the market price, so selling its gold stock earned the SNB substantial gains that could be put to good use for the Swiss population. At year-end 2000, the SNB owned 2,419 tons of gold. On a per-capita basis, this was approximately six times higher than its closest competitor (the Netherlands), seven times higher than France, eight times higher than Germany, and 12 times higher than the United States.¹⁰⁴

Abandoning its gold backing was not as simple as having the government pass a new law or the SNB declare its end. Decoupling required a:

• Parliamentary proposal to change the nation’s Constitution¹⁰⁵;

• Ratification of the Constitutional proposal by a public referendum, and

• Parliamentary repeal of Switzerland’s Coinage Act and its replacement with a new federal currency and payments law.

In February 1997, the Committee for Economic Affairs and Taxation of the National Council proposed dropping the Swiss franc’s link to gold. This proposal was followed in April 1997 by the appointment of a special commission to study the SNB’s gold holdings relative to its overall level of reserves. Among the concerns and suggestions for change was a belief that the SNB’s reserves had grown too large due to its pint-sized profit distributions to the cantons and federal government. In October 1997, the Commission’s report recommended a change in the Constitution to allow the SNB to sell 1,300 tons of its gold reserves. In a national referendum held in April 1999, the Swiss people and cantons approved the recommended change, and the Swiss federal parliament put the new Federal Constitution into force starting on January 1, 2000.¹⁰⁶

During the five years from 2000 to March 2005, the SNB sold 1,300 tons of gold, and, during a subsequent 27-month period, from June 2007 to September 2009, it sold yet another 250 tons of gold. As a result, the SNB’s gold holdings shrank to 1,040 tons, which (at the time) carried a market value of CHF 36,687 per kilogram.¹⁰⁷ One-third of the SNB’s 1,300-ton gold sale proceeds went to the Confederation and was subsequently channeled into the national Old Age and Survivors’ Insurance Fund. The remaining two-thirds were distributed to the cantons . Proceeds from the SNB’s 250-ton sale increased its foreign exchange reserves. In 2009, Switzerland’s total gold reserves (gold holdings and claims from gold transactions ) amounted to CHF 38.2 billion, representing 91.6% gold coverage of Swiss currency in circulation (CHF 41.7 billion) and 10.1% of the M1 money supply (CHF 377.2 billion).¹⁰⁸

Controversy

The timing of the SNB’s gold sales was unfortunate because they were synchronous with a period of declining precious metal prices. Between 1996 and 1999, worldwide supply and demand conditions had reduced gold prices, and, contemporaneously, a growing number of central banks had begun to sell or announced intentions to sell their gold reserves (see Fig. 7.11).¹⁰⁹

Fig. 7.11

(Source ICE Benchmark Administration Limited (IBA), Gold Fixing Price 3:00 P.M. [London time] in London Bullion Market, based in U.S. Dollars [GOLDPMGBD228NLBM], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GOLDPMGBD228NLBM, July 23, 2021)

Average monthly price of gold per ounce: January 1990 to December 2021

The IMF also expressed an interest in selling its gold holdings, giving rise to the grim possibility of a potential crash in gold prices. To bring rhyme and reason to the potentially conflicting intentions, the IMF held meetings to decide what should be done. On September 26, 1999, the Washington Agreement was negotiated, under which 15 central banks agreed to conduct orderly gold sales amounting to 2,000 tons during the period from 2000 to 2005.¹¹⁰ Sales were not to exceed 400 tons per year. Hedging currency risk was permitted, but hedging gold price risk was allowed only one year in advance. Switzerland’s gold sales quota of 1,170 tons was the clear majority (almost 59%) of the allocated sales during these five years. Under a second agreement, the SNB could sell the remaining 130 tons of gold , thereby reaching its 1,300-ton goal. Ostensibly, these gold sales were a success, with the SNB earning attractive prices relative to the average for these years.

On average, the SNB managed to sell its gold for CHF 16,241 per kilogram (US$351.40 per ounce), a price that was more than 350% above its book value. Total earnings amounted to CHF 21.1 billion, but this raised a problem. Between 1999 and 2011, the price of gold appreciated rapidly and significantly. From an average price of US$279 per ounce in 1999, gold rose to US$1,572 per ounce by 2011 and nearly $2,000 in 2020. For this reason, critics severely criticized the SNB’s decision to sell a total of 1,550 tons of gold at prices that, in retrospect, seem absurdly low. In the eyes of critics, the SNB’s gold-sale decision ranked among the most egregious financial mistakes in recent memory.¹¹¹ Had the SNB kept its gold reserves and sold the 1,550 tons in 2011, it would have earned US$78 billion.¹¹² Of course, the good to which these sales was put must also be considered.

In 2013, the conservative Swiss People’s Party reflected part of the nation’s dissatisfaction with the SNB’s gold policies when it introduced to the Federal Chancellery the “Save Our Swiss Gold” motion, which centered on three issues:

• 1. Whether the SNB could store its gold outside Switzerland;

• 2. The Bank’s right to sell its gold, and

• 3. The percent of required gold backing for the Swiss franc.

A referendum was held on November 30, 2014, which would have required the SNB to keep 20% of its assets in gold, repatriate Swiss gold held abroad, and prohibit future sales of the SNB’s official gold holdings. With strong opposition from the SNB, the referendum failed, but it opened the eyes of many to the need for greater SNB transparency and deep-rooted public concerns about the possible debasement of the Swiss franc due to a lack of gold backing.

Since 2000, when Switzerland removed gold backing from its currency, the SNB’s 1,040 tons of gold holdings have been valued at market prices. An estimated 70% of these assets are stored in Switzerland, 20% at the Bank of England, and 10% at the Bank of Canada.¹¹³ The Bank also holds gold for global financial institutions , such as the BIS , Bank of Italy , Bank of Sweden (Sveriges Riksbank ), and Bank of Finland. Before 2012, it also participated in gold lending transactions . From May 2000 to the end of June 2022, the market value of the SNB’s gold assets increased from CHF 39.3 billion to CHF 58.7 billion. This increase paled in comparison to the change in the SNB’s international currency reserves, which rose from CHF 47.9 billion to CHF 848.9 billion over the same period, resulting in this precious metal being only a tiny fraction of the SNB’s total foreign currency reserves (see Fig. 7.12). The main reason for gold’s diminishing place in the SNB’s balance sheet has been massive SNB foreign exchange interventions to reduce upward pressure on the Swiss franc’s exchange rate value, which increased significantly its foreign currency reserves.

Fig. 7.12

(Source SNB, SNB Data Portal, https://data.snb.ch/en/topics/snb#!/cube/snbimfra?fromDate=2000-05&toDate=2005-05&dimSel=D0(T0,T1,T2,T3,DAEHS,T4,ZBIZIWF,T5,DNA,T6,DNS,2RIWF,3SSZR,T7,GF,T8,DF0,DNN,U0,T9,W,G0,D,DF1,G1,U1),D1(T0,T1) [Accessed on August 19, 2022])

SNB gold and foreign currency assets: May 2000 to June 2022

Digitalization

The SNB is actively trying to understand and promote digitalization and FinTech efforts by the Swiss financial system. Digitalization offers new opportunities for financial institutions of all sizes to reduce costs, improve quality, and become more efficient. Still, it also threatens these same intermediaries with profit compression and prospects of new domestic and international sources of competition.

Payment Systems

Digitalization, communication improvements, and the increasing use of mobile payment applications have spawned a demand for instant payments available 24 hours a day. SIC5 is the SNB’s and SIX Group’s answer to the question, “Where is Switzerland’s payment system going?”¹¹⁴ The new SIC5 service is expected to start operations in 2024. By 2026, all Swiss participants on the SIC system should be able to process incoming customer payments instantly.¹¹⁵ Instant payments (i.e., in milliseconds) will be available 24 hours daily, seven days a week for each week of the year.

Cryptocurrencies and the SNB

With the introduction of bitcoin in 2009 and particularly publication of the original Libra White Paper in 2019,¹¹⁶ cryptocurrencies have captured the attention and imagination of individuals, businesses, governments, central banks , and international organizations. The scope of possible cryptocurrency varieties is broad. For example, it could be an asset created by a stateless computer algorithm (e.g., bitcoin ), introduced by a private company (e.g., Meta Platforms Inc .’s Diem , formerly called Facebook Inc.’s Libra), or created by a central bank (i.e., a central bank digital currency ). This section focuses exclusively on digital currencies issued by central banks, in general, and the SNB’s digital investigations, in particular. If a central bank digital currency (CBDC) is formally adopted, there must be ways to protect it from cyberattacks , and quickly and accurately process massive transactions , ensure payment confidentiality, and make the digital currency interoperable with existing and forthcoming payment systems .

A Central Bank Digital Currency for Switzerland?

Should the SNB introduce a CBDC or not? If so, should it be a retail or wholesale CBDC, account-based or value-based, interest-earning or not? The SNB is responsible for Switzerland’s cashless payment system. Therefore, it must be aware of financial innovations that could improve monetary policy effectiveness or facilitate an efficient and safe payment system that is not threatened with obsolescence.¹¹⁷ For this reason, the Bank has been actively studying novel cashless payment systems’ potential costs and benefits. After all, what could be more important to a country’s financial health than a safe, efficient, smoothly functioning, and low-cost payment system that connects buyers to sellers and borrowers to lenders?

CBDCs are issued and regulated by central banks or monetary authorities. Their values are tied one-for-one to the domestic fiat currency, with free convertibility in both directions. Depending on their intended use, CBDCs can be designed to earn interest or not and cleared using traditional, account-based platforms or distributed ledger technology (DLT) platforms.¹¹⁸ In general, CBDCs hold the potential to:

• Make nations’ payment and security-settlement systems more efficient and safer, by eliminating liquidity risks and counterparty default risks;

• Create immutable and transparent shared ledgers of asset information, transactions, and ownership;

• Enable operations 24 hours a day, seven days a week;

• Provide platforms for smart (i.e., self-executing) financial contracts¹¹⁹;

• Broaden and deepen system interoperability;

• Develop payment systems that are more stable and resistant to outages than current systems, and

• Encourage wider participation by serving more distant domestic and international markets and tapping into more diverse participants.

Another potential benefit of CBDCs is their use by central banks to improve the effectiveness of monetary policies. Central banks’ buying and selling of tokenized assets could be as effective as or more effective than other monetary tools. Because central banks issue CBDCs, they would be legal tender, and because central banks would be the ultimate counterparties, CBDC transactions would be free of default and liquidity risks.

Potential benefits are considerable, but the creation of CBDCs would also introduce particular risks, the severity of which are largely unknown. For example, they could increase market and settlement complexity for financial institutions and central banks. They could also introduce legal, governance, and control obstacles by trying to link different payment systems.

Retail and Wholesale CBDCs

There are two broad types of CBDCs: retail and wholesale. A retail CDBC (rCBDC) allows universal access to the general public and complements existing central bank money (i.e., currency in circulation and commercial bank deposits at the central bank). As described below, an rCBDC can be account-based or value-based.

The SNB’s position (to date) on a Swiss franc-denominated rCBDC is that it “would bring no additional benefits for Switzerland at present. Instead, it would give rise to new risks, especially concerning financial stability.”¹²⁰ In contrast to proponents’ beliefs, the SNB’s position is that an rCBDC would not bring risk -adjusted benefits to the efficiency of Switzerland’s payment systems , the effectiveness of its monetary policies, the stability of its financial system , or the ability to deter financial crimes , such as money laundering .

A wholesale CBDC (wCBDC) restricts access to approved participants, such as financial institutions that transact large interbank transactions and firms that conduct security trading, settlement, and management.¹²¹ As described below, the SNB’s position on a Swiss franc -denominated wCBDC is that it holds the potential to make Switzerland’s financial system more efficient, particularly in trading, settling, and managing securities , by eliminating the need for third-party intermediaries and having transactions conducted directly between and among counterparties.

Account-Based and Value-Based Retail CBDCs

An rCBDC can be account-based or value-based. An account-based rCBDC allows the public (i.e., individuals, businesses, and financial institutions) to hold deposit accounts directly at the central bank or indirectly there via digital central bank accounts at commercial banks. With an account-based system, settlement is only as good as the liquidity and honesty of the payer. Therefore, an account-based CBDC relies on an ability to identify participants, which means they are not anonymous, although special privacy protections could be designed for them. For example, an account-based rCBDC might allow limited amounts of anonymous cash deposits.¹²²

A value-based CBDC gives users Write- and Read-access to the database. Therefore, users enter transactions directly, without the need for the central bank as an intermediary. Rather than debiting and crediting users’ accounts, digital tokens¹²³ are transferred directly, using devices, such as smartphones, computers, and tablets, to access e-wallets on a DLT platform (e.g., blockchain ). A value-based rCBDC could be efficiently designed to provide depositor anonymity or pseudonymity, but the SNB’s likelihood of doing so is small due to the shared desire among central banks to reduce financial crimes , such as money laundering , tax evasion , and terrorist financing.

Value-based rCBDC systems are only as good as the quality and integrity of the assets being transferred. In contrast to account-based rCBDCs, wCBDC transactions do not rely on the payer’s liquidity and honesty. By analogy, think of the difference between payment by check, where the payer’s identity is essential (i.e., account-based), versus payment in cash or gold, where the asset’s value is of primary importance (i.e., value-based). Nevertheless, the SNB’s absence as a third-party ledger-keeper implies the need for verification of wCBDC transactions to prevent double-spending (e.g., much like miners verify bitcoin transactions to prevent double-spending).¹²⁴

Wholesale CBDCs (wCBDC)

A wCBDC is a tokenized asset that is issued and controlled by the central bank, and its use is restricted to approved depositors, who transfer CBDC tokens directly among themselves.¹²⁵ Because central banks monitor and control the access , issuance , settlement , and redemption of CBDCs, they are neither anonymous nor pseudonymous.

Issuance of wCBDCs and settlement of wCBDC transactions are conducted on DLT platforms. Depending on their intended use, they could replace or complement existing central banks’ wholesale systems. If they complement existing systems, then the challenges are:

• 1. Ensuring interoperability between the old, account-based systems and the new DLT-based ones;

• 2. Appropriately changing booking and reconciliation procedures, and

• 3. Determining messaging standards and new interfaces.

Rather than having the central bank act as an intermediary by debiting and crediting approved depositors’ accounts, tokenized transfers are made directly between payers and payees. In contrast to the existing central bank systems, where reserves represent a bank’s claim on a central bank liability, wCBDC transactions are actual transfers of market-valued assets. Their issuance and redemption in exchange for bank reserves do not affect a nation’s monetary base because they change only the composition of the central bank’s liabilities.

SNB Experiments with and Research on wCBDC and rCBDC Systems

The SNB has combined forces with international organizations, central banks, and financial institutions to experiment with wholesale and retail CBDCs. To date, the Bank’s major wCBDC experiments have been Project Helvetia and Project Jura. Project Helvetia is a multi-phase investigation of possible ways tokenized wCBDCs might be used to settle transactions. Until now, only Phases I and II have been completed. Project Jura’s goal was to understand if using wCBDCs for cross-currency and cross-border settlements could increase transaction speed, efficiency, and transparency, as well as lower transaction costs and risks.¹²⁶ The SNB’s major rCBDC experiment was conducted in conjunction with five central banks and the BIS Innovation Hub .

wCBDC Experiment: Project Helvetia —Phase I

In 2019, the SNB, SIX Exchange, and BIS Innovation Hub (Swiss Center) joined forces joined forces in Project Helvetia, which studied the functional feasibility and legality of integrating an SNB-issued digital currency into a DLT-based financial-payment and settlement infrastructure.¹²⁷ The Phase I report was published in December 2020,¹²⁸ describing two wCBDC trials (i.e., proof of concepts). The first one tested to see if cash settlement of tokenized-asset transactions among financial institutions could be done safely and efficiently with wCBDCs issued directly by the SNB on the Swiss Digital Exchange (SDX).¹²⁹ The second trial sought to achieve interoperability between the DLT infrastructure of the SDX and Switzerland’s real-time-gross settlement (RTGS) system, which was transacted on the SIC using cash settlement.

The takeaways from these two trials were:

• 1. A wCBDC could offer safe and efficient settlement on a tokenized asset platform;

• 2. A tokenized exchange, such as the SDX, could instruct cash settlement on Switzerland’s RTGS system;

• 3. Cash-side settlement of transactions involving digital assets can be successfully executed both ways (proof-of-concept I or II);

• 4. A wCBDC system is more innovative and encompassing than traditional payment systems because it facilitates the execution of smart contracts, and

• 5. A direct link to the SIC is close to the status quo and would, therefore, be relatively easy to implement and raise fewer policy questions, such as who has access to the system and the central bank’s role as the payment system operator.

wCBDC Experiment: Project Helvetia —Phase II

Phase II of Project Helvetia extended the work of Phase I by:

• Including five commercial banks (i.e., Citibank, Credit Suisse, Goldman Sachs, Hypothekarbank Lenzburg, and UBS),

• Showing how the SNB’s DLT-based wCBDC could “integrate and interoperate”¹³⁰ with tokenized asset markets and the existing (core) banking infrastructures, and

• Running transactions end to end, which means having commercial banks or the SNB enter settlement instructions that are matched and settled with the wCBDC on the SDX Test Platform and booked and settled on core banking system platforms.

Having interoperability between DLT-based and account-based systems was an essential dimension of this experiment, but equally imperative was ensuring the SNB had complete operative control and monitoring abilities over its wCBDCs, despite issuing them on a DLT platform that was owned by a third party (i.e., the SDX) and delegating operational responsibilities to this third-party operator. The study determined that Swiss law allows a central bank to issue wCBDCs on a third-party platform, as long as it can control and monitor their issuance, settlement, and redemption.

The experiment successfully tested the feasibility of using wCBDCs for tokenized cross-currency transactions, settlement between resident and non-resident commercial banks, and settlement between commercial banks and the SNB. Overnight wCBDCs were issued on a tokenized asset platform and integrated into Switzerland’s core banking system (i.e., the central bank and commercial banks).

For purposes of monetary policy, results showed that buying and selling tokenized assets could add a new and positive dimension to the SNB’s monetary policy toolkit (e.g., open market operations and standing facilities), as a means of changing the nation’s monetary base and interbank liquidity, but further investigations into possible problems and opportunities were necessary. Particular concerns were raised regarding the impact a wCBDC might have on trading and settlement integration, the ability of financial institutions to manage liquidity, and challenges to operational reliability and security caused by ongoing changes in technologies and systems.

Phase II tested six cases over a three value-day period. In the beginning, participant banks received reserve balances, wCBDCs, and both short-term and long-term tokenized bonds. The short-term security had a one-day maturity with redemption paid to the banks in wCBDCs.

wCBDC Experiment: Project Jura

In June 2021, the SNB’s wCBDC experiment expanded internationally with Project Jura, which was initiated by the Banque de France (BdF) in conjunction with the SNB, BIS Innovation Hub, a private consortium of banks, law firms, and technology company (Accenture and R3). Accenture led the private consortium of Credit Suisse, Natixis, and UBS. The report was published in December 2021, and the SNB’s wCBDC engagement with the BdF has continued under Project Helvetia.

Project Jura was a three-day wCBDC experiment conducted in November 2021. It tested the creation and redemption of euro-denominated wCBDCs issued by the BdF and Swiss franc-denominated wCBDCs issued by the SNB, as well as the transfer of these tokens between French and Swiss banks on a third-party, permissioned DLT platform (i.e., SDX), to which each of the three banks had access.¹³¹ The experiment linked the SDX with France’s Digital Asset Registry (DAR), a newly developed issuance platform for unlisted, tokenized commercial paper.¹³² The two central banks used notary nodes on the SDX Test Platform to control their respective rCBDCs, and the SDX used its notary node to control the tokenized commercial paper. For these transactions to be immediate and atomic,¹³³ the notary nodes needed to interact by signing and time-stamping transactions in their respective rCBDCs.

Business was conducted using the existing legal and regulatory frameworks in France and Switzerland, but the euro wCBDC, Swiss franc wCBDC, and tokenized commercial paper had no legal force because the wCBDCs were not direct central bank liabilities and the tokenized commercial paper was issued on SDX’s Test Platform. The three days played out as follows:

Day One: Tokenized Commercial Paper Issuance and Cross-Border Exchange of CBDCs

• Natixis, a French-based corporate and investment bank, issued tokenized commercial paper worth EUR200,000 on the DAR, which was mirrored on the SDX Test Platform.

• Natixis sold the tokenized commercial paper on the intraday market to UBS for euro-denominated wCBDCs (EUR wCBDCs).¹³⁴ UBS obtained these EUR wCBDCs by using Target2 ¹³⁵ to exchange EUR200,000 with the BdF for an equivalent amount of EUR wCBDCs,¹³⁶ which the BdF created on the SDX Test Platform .

• Credit Suisse used the SIC to exchange Swiss franc deposits at the SNB for Swiss franc-denominated wCBDCs (CHF wCBDCs), which were created on the SDX Test Platform.¹³⁷ The transfers were executed automatically, instantaneously, and atomically.

• The day ended with Credit Suisse using the SDX Test Platform to trade its CHF wCBDCs for Natixis’s EUR wCBDCs.¹³⁸

Day Two: Sale of Tokenized Commercial Paper for EUR CBDCs

• UBS exchanged its newly acquired tokenized euro-denominated commercial paper for Credit Suisse’s EUR wCBDCs.¹³⁹

Day Three: Commercial Paper Redemption and Settlement in CBDCs

• Natixis’s commercial paper matured, and Credit Suisse redeemed it for EUR wCBDCs.¹⁴⁰

• Natixis and Credit Suisse used the SDX Test Platform to trade Credit Suisse’s EUR wCBDCs for Natixis’s CHF wCBDCs.¹⁴¹

• The day concluded with UBS and Credit Suisse redeeming their wCBDCs and the two central banks destroying them. As a result, UBS increased its reserve deposits with the BdF, and Credit Suisse raised its reserve deposits with the SNB.

The study demonstrated how a well-designed, DLT-enabled wCBDC could be used “to settle tokenized financial instruments and foreign exchange transactions across borders.” On the positive side, it could reduce risks by:

• 1. Increasing the use of DvP and payment-versus-payment (PvP) settlement;

• 2. Broadening the utilization of central bank money;

• 3. Enhancing competition by employing a tokenized ecosystem to diversity settlement and provide operational back-up, and

• 4. Simplifying liquidity management and lowering costs for non-resident banks by granting them access to wCBDCs.¹⁴²

Two key features of the EUR wCBDC and CHF wCBDCs were their intraday settlement, which allowed immediate availability of funds to non-resident banks. Efficiency gains came from making trade execution, payment, and settlement a single transaction. The study illustrated the power of central bank and private market cooperation to foster cross-border innovation, reduce liquidity fragmentation in global correspondent bank relationships, and further the use of central bank money.¹⁴³ Moreover, this new settlement system could be conducive to financial stability and enhance the operational efficiency of primary and secondary security transactions .

Future study will be necessary. Particular concerns focus on:

• 1. How the results of this experiment might change if settlement instructions on the SDX Test Platform were fully automated;

• 2. The impact wCBDCs might have on the integration of tokenized securities;

• 3. Accounting, statistical, and regulatory reporting modifications that will need to be made;

• 4. Effects on technical performance and error correction, and

• 5. Privacy and cyber security.

SNB’s rCBDC Experiments and Studies

Most of the SNB’s discussions on rCBDCs have focused on those that have legal-tender status and lack anonymity (i.e., account-based rCBDCs). This virtual currency would serve as the nation’s “official” money, implying a successful rCBDC would need to function as a unit of account, medium of exchange, and store of value.

As mentioned in Chapter 3, the Wermuth Postulate was submitted to Switzerland’s National Council in March 2018, requesting a detailed report on the feasibility of a Swiss-franc-denominated rCBDC.¹⁴⁴ In January 2020, the SNB, Bank of Canada, Bank of England, Bank of Japan, ECB, Sveriges Riksbank (Bank of Sweden), and BIS Innovation Hub used this report to study an rCBDCs’ potential risks, advantages, and prospects.¹⁴⁵ Members agreed to coordinate and share their findings with other international organizations, such as the Financial Stability Board (FSB). The group’s mission was to assess rCBDCs’ uses in terms of “economic, functional and technical design choices, including cross-border interoperability ; and the sharing of knowledge on emerging technologies.”¹⁴⁶ Its foundational principles were to “(1) ‘do no harm’ to monetary and financial stability ; (2) coexist with cash and other types of money in a flexible and innovative payment ecosystem ; and (3) promote broader innovation and efficiency .”¹⁴⁷

From these studies and other investigations, the SNB’s position (to date) is that rCBDCs would not, at present, serve the overall interests of Switzerland. In general, it does not see the net advantage of a rCBDC over the forthcoming SIC5 payment system. The Bank based its position on the risk-adjusted costs and benefits in eight focal areas:

• 1. Broadening financial inclusion;

• 2. Reducing default risk;

• 3. Lowering transaction costs;

• 4. Improving monetary policy effectiveness;

• 5. Enhancing global financial interoperability;

• 6. Improving overall financial stability;

• 7. Reducing financial crime, and

• 8. Potentially challenging legal implications.

Broadening Financial Inclusion

• An rCBDC holds the potential to reach unbanked or underbanked segments of a country, especially in light of the global increase in cashless payment alternatives, declining fiat currency usage, and significant increases in online shopping. The SNB believes Switzerland’s financial system already has a healthy number of financial institutions for its population and found no signs of significant reductions in Switzerland’s cash acceptance. In fact, a 2017 study learned that cash was responsible for 70% of Switzerland’s non-recurring household payment transactions and 45% of total transaction volume if measured by value. Therefore, the Bank concluded that the marginal benefits (if any), in terms of inclusion, were likely to be small.

Reducing Default-Risk

• An account-based rCBDC would be risk-free, providing the Swiss population with greater security than commercial bank deposits, which are subject to default risk and lack “legal tender” status. The SNB believes that the marginal benefits from this type of safety are relatively small because Swiss bank deposits are already insured and cantons, except Bern, Geneva, and Vaud, guarantee the deposits of cantonal banks. Customers concerned about the safety of a Swiss financial institution can switch to ones with cantonal guarantees. Furthermore, the chances of massive defaults triggered by systemic illiquidity are negligible due to the SNB’s ability to create monetary base at will.

Lowering Transaction Costs

• rCBDCs enable direct transfers, thereby eliminating third-party intermediation. Therefore, they hold the potential to reduce transaction costs. The SNB believes these marginal gains, if any, are likely to be small in light of the nation’s already-advanced financial system. Switzerland continues to improve its domestic and international interoperability, and significant challenges in this area would arise if Switzerland were to adopt an rCBDC. Furthermore, the Bank questions the source of these gains, considering it has the same access to technology as the private sector.¹⁴⁸

Improving Monetary Policy Effectiveness

• An rCBDC could give the central bank exclusive control over its domestic money supply by eliminating fractional banking, but the SNB questions the net benefits relative to other efforts, such as improving its current financial infrastructure. The Bank recognizes that an rCBDC that eliminated cash could enhance its ability to set negative interest rates because depositors could not avoid penalty rates by retreating to cash. However, the SNB has already reduced nominal interest rates below zero, so enhancing these abilities might provide greater control but also more significant risks.

Enhancing International Interoperability

• A successful rCBDC would require interoperability with foreign systems, which might force countries to increase the pace of advancement. At the same time, the transition period would raise new risks because Switzerland’s rCBDC would need to be coordinated with other countries that have and have not adopted them.

Improving Overall Financial Stability

• The SNB is doubtful that a Swiss rCBDC would improve financial stability. One potential benefit is that an rCBDC could make banks more risk-averse to avoid possible runs and ensure their abilities to refinance assets. At the same time, rCBDCs have the power to activate runs if depositors transfer funds to the central bank. These runs could be on a massive scale, ignited with just a few clicks of depositors’ keyboards. The SNB believes that Switzerland’s financial regulations, particularly due to changes since 2008, have significantly reduced the risk-taking activities of domestic banks, making the risk-adjusted marginal benefits of an rCBDC low or negative.

Reducing Financial Crime

• If rCBDCs were designed without anonymity, they could reduce financial crimes, such as money laundering, drug trade, tax evasion, tax fraud, and terrorist financing, by tracking the illegal steps of individuals, businesses, international institutions, and governments. At the same time, an rCBDC would become a prime target for cyberattacks, and if successful, the results could be consequential due to the potential magnitude and speed of the monetary disruption. The SNB believes that continued efforts by OECD and G20¹⁴⁹ members to increase bank transparency and lower cash payment thresholds for due diligence are more likely to succeed than introducing an rCBDC.

Potentially Challenging Legal Implications

• The legal adjustments that might be needed are highly uncertain because they depend on the type of rCBDC created. Regardless of the specifics, the CHF rCBDC would need to be controlled and regulated by the SNB, Confederation, or both. Among the important questions in the public law area are: What are the limits of power and responsibility between the SNB and Confederation? Would the rCBDCs be legal tender? What are the limits (if any) on third-party delegation? What would be the role of financial intermediaries? How would AML regulations be enforced? What degree of privacy should be granted?

  Among the important questions in the civil law area are: What are the liability implications when the technical infrastructure’s operations fail, allowing theft, fraud, or privacy violations. Does liability change if responsibilities are outsourced? For international transactions, how are issues of jurisdiction settled?

Swiss Sovereign Money (Vollgeld) Initiative

In June 2018, Switzerland held a popular referendum that would have given the central bank exclusive power to create money.¹⁵⁰ If successful, fractional banking in Switzerland would have vanished, with banks required to hold 100% reserve assets against their deposit liabilities .¹⁵¹ In short, the initiative would have taken the creation of money out of the hands of private banking institutions and placed it fully with the SNB.

The SNB opposed the Swiss Sovereign Money Initiative (aka, Vollgeld Initiative), believing that it would impede the Bank’s ability to control the money supply.¹⁵² Banks, the Swiss Parliament , and the government also opposed the initiative, causing its sound defeat, with 76% of Swiss voters in opposition. “Don’t fix something if it’s not broken” seemed to be the prevailing sentiment. Because Switzerland already has one of the healthiest financial systems in the world, many concluded there were too many important uncertainties. The risks were too high for the expected rewards.

The SNB and Non-CBDC Cryptocurrencies

While the SNB has been testing the efficacy of its wCBDC, there remain open questions about how it intends to treat the proliferation of new cryptocurrencies and the maturation of existing ones. Currently, the SNB does not perceive unbacked cryptocurrencies, such as bitcoin and ether, as significant threats to its mandate because they are not used widely as units of account or mediums of exchange, and their price volatility makes them unreliable stores of value.

FINMA classifies cryptocurrencies by the functions they perform. Among the reasons for different treatments are concerns about individual and data privacy, the need for bank licensure, and know-your-customer (KYC), anti-money laundering (AML), and anti-terrorist funding rules. In general, cryptocurrencies are regarded by Swiss authorities less as “money” and more as investment assets, which can be used to diversify investors’ portfolios.

While the SNB does not (currently) consider unbacked cryptocurrencies significant threats to its mandate, there are concerns about stablecoins, which have been pegged to official currencies, such as the U.S. dollar and, therefore, to the monetary policies of the respective central banks. Despite being backed by official currencies, stablecoins are claims against particular issuers and not against central banks. Therefore, their credibility is linked directly to the trustworthiness of the issuers.¹⁵³ The SNB’s uneasiness is focused mainly on stablecoins tied to one-or-more foreign currencies because large currency inflows and outflows could affect the Swiss franc’s international value and pressure the Bank into undesired foreign-exchange-market interventions. Stablecoins linked to the Swiss franc are perceived as less threatening because the SNB has significant control over domestic monetary policies, which can be used to influence unwanted changes in interest, wage, and inflation rates.

Principality of Liechtenstein

In 1980, the Principality of Liechtenstein (population 38,235) signed a currency agreement with Switzerland (population 8.7 million), making the Swiss franc Liechtenstein’s national currency and designating the SNB as its central bank, legalizing what had been the practice for almost 100 years.

Conclusion

The SNB conducts monetary policy to serve the country’s interests as a whole. To maintain public confidence in financial stability, the Bank operates independently, based on a firm belief by the Swiss government and population-at-large that an independent central bank is the best way to keep inflation low and economic growth steady. More than 100 years of experience have proven this policy correct. Since 2000, the Bank has followed multifaceted monetary strategies, with a primary goal of keeping inflation in the range of 0.0 to 2.0%. Due to the financial crisis (2007 to 2009), sovereign debt crises, and COVID-19 pandemic, the SNB (like many other central banks) has introduced several unconventional monetary measures to derail the threat of deflation, mainly caused by a dangerous appreciation of the Swiss franc.

Because exports are essential to the Swiss economy, exchange rates and price stability will continue to be important in formulating and executing the SNB’s monetary policies. Switzerland is a relatively small, open economy, causing the SNB to walk a razor’s edge between controlling exchange rates and the money supply. Any attempt to significantly influence the Swiss franc’s value can result in sizeable changes in the nation’s monetary base and money supply due to the foreign exchange market’s disproportionate size relative to the Swiss domestic markets.

Because of its persistent expansionary monetary policies (especially since 2007), the SNB’s balance sheet has expanded massively, with much of this increase tied to the accumulation of foreign exchange reserves. Future SNB policies will be influenced by those of the past and the positions they have created. Because its balance sheet is significantly larger, more leveraged, and currency imbalances between assets and liabilities have grown, the SNB’s earnings have varied considerably. Unless these factors are controlled, this volatility will be more significant in the future.

Due to the size of the SNB’s foreign currency reserves, active discussions have been held regarding the creation of a for-profit Swiss Sovereign Wealth Fund (S-SWF).¹⁵⁴ Such a fund would free the SNB from political pressures regarding foreign currency management and allow the Bank to focus on stabilizing the Swiss economy. Issues abound, such as:

• How should the S-SWF’s profits be distributed?

• What happens when the S-SWF’s activities interfere with the SNB’s monetary or exchange rate policies? and

• To whom would the S-SWF be accountable?

Switzerland entered the third decade of the twenty-first century determined to strengthen the domestic financial system and Switzerland’s global financial role. Progress has been made by introducing new capital and liquidity requirements for banks, addressing the “too-big-to-fail” problem, and confronting the challenges of central bank digital currencies, cryptocurrencies, environmental sustainability, digitization, speculative international capital inflows, and the evolution of Fintech competition and innovation. Because the SNB’s future will be tied to basic principles, such as independence, transparency, cooperation, inclusiveness, and acting on behalf of the nation as a whole, reforms are likely to be evolutionary rather than revolutionary.

The SNB recognizes CBDCs as potentially paradigm-changing instruments for the future. Among their potential benefits are enhanced financial stability, security, and privacy. They also enable more fluent employment of new technologies that can improve the efficiency of cross-border payments, lower costs to consumers, broaden accessibility, increase diversity, and strengthen monetary policy effectiveness.

A key to CBDCs’ success will be interoperability at the domestic and international levels so funds can flow seamlessly from one payment system to another. To be effective, a CBDC system would need to involve both the public and private sectors to guarantee interoperability on as wide a scale as possible. Despite the potential benefits, the SNB and Swiss Federal Council share the belief that a wCBDC holds prospective promise, but at present, an rCBDC would not provide Switzerland with net risk-adjusted benefits. The nation already has a highly efficient and productive financial system, and the risks to its stability are too high.