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Switzerland Politics May 2018

Switzerland: Referendum on banking reform could throw the country into uncharted waters

The Swiss electorate will vote on 10 June on a radical proposal, known as the sovereign money initiative (Vollgeld), to overhaul the country’s banking and monetary systems. Voters will decide on whether to change the current fractional reserve banking system, where private banks increase the money supply through loan issuance, to a sovereign money system. Under the proposed system, the Central Bank would become the sole institution in the country that can increase the money supply. While such a change could eliminate the risk of bank runs, it would also likely restrict credit, politicize the role of the Central Bank and create significant economic uncertainty.

Proponents of a sovereign money system argue that it would make the financial system more robust by eradicating debt-fueled speculative bubbles in the economy and removing the possibility of runs on sight deposits, thus avoiding costly government bailouts of private banks. However, such a system has never been implemented in any other modern economy and would throw the country into uncharted waters. The Swiss banking sector is among the largest and most highly developed in the world. It is also closely integrated into the world economy, implying that any fundamental change to it would have ripple effects throughout not only the country but also the world. While the latest opinion polls put the “no” camp in the lead, an upset cannot be ruled out.

Private banks under a sovereign money system would not be able to issue loans and increase the money supply in Switzerland. This would curtail their source of funding, and their ability to lend could be severely limited. Dwindling funding would result in higher borrowing costs and particularly hurt households and private businesses. In turn, The Swiss National Bank (SNB) would take a more prominent role in the economy. There is concern that under the proposed system the SNB could become politicized and face a loss of independence. The Central Bank would lose access to a common monetary policy tool, as they could not acquire or sell assets when issuing money. The Bank’s balance would worsen if they decided to purchase assets, which implies that the SNB would take a more precautionary stance in implementing accommodative monetary policy.

An unlikely victory would generate extreme uncertainty in the direct aftermath of the vote, as did Brexit in the United Kingdom. The referendum bill envisages a three-year window for the SNB to implement the new system, but there is no clear roadmap, and the implementation would face many legal and functional hurdles. In that three-year period, the SNB could mitigate any short-term impact through existing monetary policy instruments. Nevertheless, some collateral damage can be expected due to heightened uncertainty. On this point, economist Charlotte de Montpellier from ING commented on how ING’s foreign exchange forecasts will change if the referendum is approved:

“The uncertainty of re-wiring the monetary and banking system in Switzerland would probably be negative for the CHF. Wider credit spreads and more limited access to credit should pose headwinds to an economy already suffering persistently low inflation. Some models put EUR/CHF fair value at 1.50 and we would say the uncertainty could see EUR/CHF rise above 1.30 from near 1.20 today.”

However, once the dust settles, the currency would likely recover from uncertainty-induced shocks. The Bank’s more conservative stance resulting from the new system’s expected constraints would contribute in supporting the recovery of the currency.

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