The Banking System in Switzerland - Essay Example

Running Head: Swiss banking system Critically evaluate the banking system in Switzerland. 0.Introduction. 1.1 General description of the banking system Switzerland is considered one of the leading financial centers in the world. Banking is the largest industry in Switzerland with about 5% of the country's workforce employed directly or indirectly in this sector. This is a direct result of a combination of factors namely: The banking secrecy provision, The stability of the Swiss franc The favorable political and economic climate The policy of neutrality Exceptional financial infrastructure like specialized lawyers. First-class telecommunication infrastructure. Multilingualism. Dense representation in other financial power centers around the world. Investment business and asset management has also been going strong over the years. 1.10 Developments in Banking Legislation and regulations: A new law that allows foreign banking institutions to run branch offices in Switzerland without authoritization by the FBC. Another law on investment funds was also enacted at the same time. This law abolished limitations associated with assets investment funds The "Federal Law on Combating Money Laundering in the Financial Sector" came to force in 1998 and enhanced due diligence obligations on the part of all financial intermediaries. In 2002, the FBC called for stricter regulations to combat money laundering and the funding of terrorist activities as well thorough regulations in dealing with assets belonging to infamous political figures. An edict calling for eradication of unidentified overseas money transfers was introduced in 2003. These legislation have aimed at streamlining the structures and offer more flexible systems in order to improve competitiveness. 1.2 The Universal system The universal banking system in Switzerland, allows all banks to offer varied financial services other than the traditional banking activities. The services include: Deposit Lending Payment transactions Investment consultancy & asset management Securities trading e.g. stock exchange Financial analysis Management of investment trust and mutual funds. 1.3 Categories of Banks. However, there are several specialized banking groups in Switzerland. The domestic banking market is dominated by eight groups of banks. Two of the largest banks, United Bank of Switzerland (UBS) and the Credit Suisse Group, offer varied financial services that include portfolio management and underwriting. They also participate in the stock market. Cantonal banks: There are 24 cantonal banks that are Semi-governmental organizations. Their main role is to local financial needs including acceptance of savings deposits and granting of loans. Regional and savings banks: These are mainly corporations or cooperative societies and are also local in nature. The Raiffeisen group mainly operates in communities spread around the country. They offer financial services by organizing the local resources and giving credit facilities at low interest rates. Private banks: are mostly partnerships Branches of foreign banks and other banks make up the other main bank groupings1. Microeconomic Factors 2.1 Deposit acceptance and lending Switzerland has seen a reduction of the number of banks from more than 600 banks in 1990 to slightly more than 350 in 2004 courtesy of consolidation and mergers. It is the purpose of this paper to look at some of the considerations taken into account by the regulatory authorities (Swiss National Bank & The Federal Banking commission) as they endeavor to provide direction for banking institutions. Deposit acceptance and lending are some of the fundamental functions of banking institutions. A section of this paper will focus on costs and degree of risk associated with banks' lending activity in a rapidly changing financial market. Hanson, J.L. (1974) Mergers bring with them opportunities as markets increase but they also cause an increment and volatility of risks. They add to the convolutions facing monetary policy makers. For instance quick increases in deposits as a result of momentary saving upsurge can push the probability of maturity mismatches. Bradford, Shleifer, Summers & Waldmann. (1998). This might in turn result in adverse selection where banks lend at higher than average risks. The opposite is also true where banks withhold their lending activities. This adversely affects exchange rates and puts undue pressure on interest rates (Goodhart, C. & Gerhard, I. 2002,). Liberal capital markets increase risk instability because banks seek higher returns in international financial market. These returns are usually impulsive in nature and as investors usually have less information than about the risk of these investments, credit rationing could occur (Stiglitz and Weiss 1981). In some cases merged banks can become very big like in the case of credit Suisse (CS group) which in recent years have acquired several other banks notably 'the Volksbank' and Bank Leu. Also worthy mentioning here is the agreement between Zurich Financial Services and Deutsche Bank. According to (Gallagher, L. A. & Mark, P. T. 2002,) if merged banks acquire the image of "too big to fail", this is likely to cause moral hazard issues in view of its position and influence. This may compromise policy decisions. 2.2 Risk. Another function of the regulatory authorities is to build confidence in the system so that there is transparent and rigorous intermediation between depositors (savers) and investors (entrepreneurs). However, increased foreign investments in Switzerland and cross-border financial transactions heightened by such factors as - advancing technology in financial software, the fall of the Berlin Wall and improved international telecom as well as an increased globalization of the money market business from both the investor and saver side - has meant that a considerable portion of Swiss financial activity is only indirectly subject to the Swiss banking regulatory authorities. In line with the global trend as well as the growth in these cross-border transactions, financial market contenders have broadened horizons and in so doing achieved diversification of their risk exposure through selection of modern financial options that allow higher returns on investment. These options however carry certain inherent risks. This means that the modern day savers and investors are more exposed to shocks that permeate national boundaries like the recent financial instabilities in Japan. The tremendous growth in the use of these financial instruments and derivatives has impacted positively on the participant's abilities to circumvent the adverse effects of exchange rate and price instabilities (Andreas M. F. 2005). It is however evident that misinterpretation of the risks involved or abuse due to moral hazard issues can have devastating consequences. The Swiss banking system has seen accelerated changes with, liberalization and globalization enhancing the visibility of competition. This has shaped the banking industry in recent times. Various services like Restoration of loans, deposits/capital dividends et cetera, are now performed through any bank within the Swiss network. It is possible to dispose export takings liberally. Leading and lagging of import and export payments can be done without limitations, and prior authorization is not a requirement. Several other financial transactions can be carried out without prior authorization from FBC. These are just a few of the rules enacted to enhance competitiveness. 3.1 Benefits and drawbacks of the changing system. There are some benefits and some drawbacks of the liberalized system in light of the effects on the deposit and lending market as well as investment management. Drawbacks Creation of debt or credit rationing. Banks are now taking high-risk strategies in pursuit of bigger profits. This is happening without proper knowledge of savers and investors. This form of asymmetry of information has the potential of creating debt or credit rationing. The traditional market regulators like the SNB & FBC, competition and disclosure requirements are slowly losing their grip. The supervisory functions of the Federal Banking Commission have minimal application in light of the modern international financial services. Competition is being reduced by the many consolidation efforts and the warning offered by disclosures is usually too late. Exposure to international shocks. Due to cross-border transactions investors and other stakeholders banking in Switzerland are exposed to shocks caused by downfall of financial institutions elsewhere in other regions of the world. Benefits. Improving competitive conditions. Changes have become inevitable especially after the stock exchange adjustment in 1987, where the Swiss stock exchange lost a lot of foothold. Increasing efficiency. With the increase of new technologies especially in the financial segment and specifically in the security trading, it is now possible to bypass bank tellers or even ATMs and do your banking at the convenience of your home through virtual banking. Conclusion. In conclusion, it is worthy to note with the improved efficiency and lower transaction costs; the quantity of financial transactions has increased tremendously. The abolishing of exchange regulations has seen the rapid increment of cross-border capital flows to the traditional markets and also to emerging markets. This is blurring the regulatory boundaries of different regulatory authorities. Financial services are becoming increasingly sophisticated. The rapid growth of non-traditional financial instruments and collective investment services is yet to be tested by severe shocks from local sources or overseas. These changes, have introduced major insecurities in the financial and banking system in Switzerland. They also play an important role in highlighting the structural frailties of the Swiss banking sector that may call for the strengthening of the regulatory authorities. However it is the opinion of this paper that the Swiss banking industry and system is sound and able to withstand significant economic shocks. Bibliography. 1. Andreas M. Fischer: On the Inadequacy of Newswire Reports for Empirical Research on Foreign Exchange Interventions-Swiss National Bank Working Papers published in 2005: 2. De Long, J. Bradford, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann (1998) Positive feedback investment strategies and destabilizing rational speculation, The Journal of Finance 3. Gallagher, Liam A., and Mark P. Taylor, 2002, (ed) Speculation and Financial Markets, An Elgar Reference collection, Volume I, Chapters 12, 14, 15 and 16. 4. Goodhart, Charles, and Gerhard Illing, 2002, Financial Crises, Contagion, and the Lender of Last Resort - A Reader, Oxford University Press, Chapters 8, 13, 15. 5. Hanson, J.L. (1974. 6th ed). A Textbook of Economics. London, Macdonald& Evanson LTD. 6. Stiglitz, J. and A. Weiss, 1981, "Credit Rationing in Markets with Imperfect Information," American Economic Review, 71(3), June, 393-410 7. WEF, Global Competitiveness Index 2006 Word count 1521. Read More