Radical reform: Switzerland to vote on banking overhaul

Supporters promise the proposal will end boom-and-boost, but critics say it is a dangerous experiment

Ralph Atkins in Bern

© Reuter

Early one recent sunny Friday morning, as many Swiss planned weekend hikes in the mountains, seven activists sprayed a slogan on hoardings near the Bern head office of Switzerland’s central bank. “Please remember why we created you,” it read in big red letters.

The dawn action, a rare act of rebelliousness in the famously conservative Alpine state, coincided with the Swiss National Bank’s annual shareholders’ meeting. It was the latest protest by a group of Swiss economists and campaigners ahead of a referendum on June 10 on radical reforms to the way a modern economy functions.

The campaigners’ proposals would ban commercial banks from “creating” money through their lending to businesses and consumers. As they see it, the objective is to stop bankers from — again — putting Swiss voters’ savings at risk by reckless lending that could blow up the financial system.

Instead, they propose that the SNB should re-assume what they argue is its constitutional role — as defined in an 1891 referendum — as the monopoly provider of Swiss francs. “The will of the people has been forgotten,” reads their campaign literature.

“The experts are convinced the financial system will crash again — they just don’t know when,“ says Raffael Wüthrich, one of the Bern activists. “If that’s the case, we should make sure our money is safe.”

The campaign is resonating internationally because it has pitted the anti-establishment anger generated by the 2007-8 financial crisis against defenders of the global financial system — led in Switzerland’s case by the SNB.

Sergio Ermotti, UBS’s chief executive, recently told journalists bluntly: 'I don’t expect the Swiss people to be suicidal and approve it [Vollgeld]' © Bloomberg

The proposals have tapped into a wide array of political currents, from the libertarian right, which has long debated the issue of how money is created, to leftist critics of the power of private banks. “Vollgeld [or “sovereign money” initiative] fits with a long-running debate among economists that re-erupted after the financial crisis — not just in Switzerland and Germany but countries from the US to the UK and Iceland,” says Nadia Gharbi, an economist at Pictet in Geneva.

Thomas Jordan, the SNB’s chairman, warns the Vollgeld would be a “dangerous experiment” that would destroy a functioning banking model and could also damage the economy.

Yet even critics admit the protesters have a point and are prompting a necessary post-crisis debate about the way that financial systems actually work. “The idea that we need to reform finance is mainstream — it’s not absurd to think we could have a much better system,” said Hans Gersbach, an economics professor at ETH Zurich, a federal institute of technology. “But Vollgeld is the most radical option one could have.”

The Swiss campaign has taken on even greater relevance because it coincides with the rise of cryptocurrencies — digital forms of payment, such as bitcoin, which use blockchain technologies — whose supporters have often echoed many of the same themes.

Like notes and coins, cryptocurrencies could be backed by the central bank and supporters say their virtual format would allow them to circulate much more widely and to potentially replace ordinary bank accounts.

As a result of the bitcoin mania, central bankers worldwide have started to debate whether they should one day issue e-versions of national currencies — even if the SNB is among the most vocal warning of possible dangers.

Thomas Jordan of the SNB warns the sovereign money initiative, would destroy a functioning banking model © Bloomberg

“The origin of this [Vollgeld] initiative had nothing to do with e-money or cryptocurrencies issued by the central bank,” Mr Jordan told the FT. “But of course it also deals with the basic question of general public access to central bank money and the consequent impact on the financial system.”

Switzerland has an outsized financial sector — despite its small size, it is the world’s biggest centre for managing cross border wealth. But it has become a test ground for such a radical proposal because, under its system of direct democracy, just 100,000 signatures are required to force a referendum.

Vollgeld’s basic idea is to abolish “fractional reserve banking” — the basis for financial systems around the world. Under fractional reserve banking only a portion of deposits held by banks on behalf of customers are backed by “central bank money”, comprising of notes and coins, or the deposits that banks hold at the central bank. The result is that when banks issue new loans to businesses or individuals, they are often creating new money in the economy.

Under Vollgeld, the amount of money injected into the economy would be overseen by the central bank — rather than profit-maximising banks — which, supporters say, would help prevent credit-fuelled boom and bust cycles. The SNB would also have the authority to allocate central bank money to the government — or even directly to the public — although this could fuel fears of inflationary monetary policies.

Jean-Marc Decressonnière, a banker in Basel, was taken aback when he realised he was responsible for creating money. “It was a surprise — we were simply not aware.” He is one of three managing directors at the Freie Gemeinschaftsbank in Basel, a not-for-profit finance house which focuses on lending to ecological, community and educational projects and tries to demonstrate “ethical” banking can work.

“A client rang and mentioned the Vollgeld idea — and said ‘you create money, how can that be?’ And I said, ‘no, we don’t create money, we’re an intermediary’. But we were confronted by the Vollgeld initiative, which made us reflect on how far involved we are in the creation of money.”

Instrumental in his thinking, Mr Decressonnière said, was a research paper published in 2014 by the Bank of England which pointed out that — contrary to popular understanding — most money in a modern economy was created electronically by commercial banks. In the UK, it is about 97 per cent, in Switzerland about 90 per cent, according to the Vollgeld campaign.

Proponents of the reforms say the SNB should re-assume what they argue is its constitutional role as the monopoly provider of Swiss francs © EPA

Mr Decressonnière now believes money creation should be under the control of a state institution — not bankers eyeing their bonuses. “Our view is that money is a public good and it is right that there should be a macroeconomic perspective. A commercial bank has a very narrow perspective — namely, to make money.”

But Mr Decressonnière is one of the few bankers in Switzerland backing the Vollgeld campaign. Nobody has worked out what the exact effect would be for Swiss banks — the referendum proposal leaves implementation details unclear. The country’s large private banks would be largely unaffected — managing the wealth of the world’s rich is their main business, not lending in Switzerland. UBS and Credit Suisse, the country’s two largest banks, have large international operations, which would also probably not feel much impact.

Nevertheless, Swiss bankers in general believe the Vollgeld proposals would threaten their domestic business models, hamper economic growth — and put Switzerland at a competitive disadvantage. Nor would they prevent future crises, critics say. “It is not going to make the system 100 per cent safe,” said Daniel Kalt, chief Swiss economist at UBS. “There would be a reduced risk of bank runs caused by panicking savers, but the problem in 2008 was that banks lost access to wholesale funding, and that could still happen.”

Sergio Ermotti, UBS’s chief executive, recently told journalists bluntly: “I don’t expect the Swiss people to be suicidal and approve it [Vollgeld].”

The debate has not been easy for the SNB to navigate. Normally, it steers clear of political controversies. But on this issue Mr Jordan sees a responsibility to intervene. “On a matter which is directly linked to our mandate, it is imperative that the SNB states its views as clearly as possible,” he told a Vollgeld supporter at the central bank’s annual meeting.

The SNB chairman argues that new credit from bank lending is essential for economies to function, but Vollgeld would put “grit” in the system, making it more complicated and expensive. Moreover, Vollgeld would return Switzerland to “monetary targeting” — where the central bank tries to control the supply of money flowing in an economy — a system the SNB argues was discredited and abandoned 20 years ago.

Vollgeld supporters dispute this last point, saying the SNB could still use changes in interest rates to influence economic activity, rather than artificial money supply targets.

However, Mr Jordan also worries Vollgeld would overburden the central bank with powers, which could lead to questions about its political legitimacy, especially if something went wrong. Injecting money into the economy for governments or citizens would be easy in the good times; but withdrawing it when the central bank deemed policy tightening was needed would be much more controversial. “Our power should be limited to what we need to fulfil our legal mandate. More is neither necessary nor sensible,” Mr Jordan told the FT.

What is more, according to Mr Jordan, Vollgeld’s proponents have failed to take account of regulatory reforms which have strengthened the banking system since 2008.

“There will always be economists who find some ideas very interesting and they come up with a very specific model or an extreme scenario under which Vollgeld would work better than the existing system. But we have to deal with the realities,” he says. “We are convinced that the existing system, with all the improvements that we have made in the last couple of years, is far superior to introducing a Vollgeld system.”

Zug, Switzerland’s burgeoning 'crypto valley' of crypto and blockchain start-ups outside Zurich

What will happen on June 10? An opinion poll this month by the SRF public broadcaster showed just 35 per cent of Swiss voters in favour in Vollgeld. Some 49 per cent were in the “no” camp, and 16 per cent undecided. In the past two years, the Swiss have also rejected similarly radical plans to abolish TV licence fees and introduce a “universal basic income” for all citizens.

Notably, the Vollgeld campaigners have failed to win over fellow rebels in Switzerland’s burgeoning “crypto valley”, the network of crypto and blockchain start-ups in Zug, outside Zurich.

Prof Gersbach at the ETH in Zurich sees a clear link between digital currencies and reforming the financial system. “If a central bank issued a cryptocurrency, and it became enormously popular — perhaps because it paid interest — then it would substitute for bank deposits created by banks as a means of payment. The whole system would move towards a system in which there was only central bank-issued money — it would be a type of Vollgeld.”

But crypto pioneers see crucial differences, including the shift to greater state economic planning that could arise from the government being more involved in lending decisions. “On one side, [the cryptocurrency pioneers] it is very libertarian in the true sense — and on the other there is old fashioned economics,” said Richard Olsen, founder and chief executive of Lykke, a Zug-based blockchain financial Exchange.

Whatever happens on June 10, Vollgeld supporters say their fight will continue. “The Vollgeld has led to a lot of critical thinking and reflection about the current system — and whether it’s still appropriate. It’s not immune against all criticism,” said Mr Decressonnière in Basel.

Bern protester Mr Wüthrich says the Swiss are, historically, slow adaptors. Pension reforms and votes for women took several referendums before they were accepted. The referendum would not end the debate, he says, because “the idea that only the central bank should manufacture money is too reasonable and sensible”.

International support: Reform ideas date back to the Great Depression

Irving Fisher © AP

The Vollgeld proposals may be a response to the 2007-8 financial crisis but they are similar to ideas which emerged in the US in the 1930s, in the wake of the Great Depression. In 1935, the economist Irving Fisher proposed a “100 per cent reserve banking” system to eliminate bank runs, smooth economic cycles and reduce indebtedness.

Fisher’s ideas were never implemented, but became fashionable again after 2007. Support has come from surprising quarters. In 2012, a “working paper” published by the International Monetary Fund found empirical support for Fisher’s claims. What was more, they would also boost economies while keeping inflation low, the report’s authors argued.

“That paper challenged the easy prejudice that said we could not have a better financial system,” said the economics professor Hans Gersbach.

Academic economists have been “brainwashed” by maths-based courses which largely ignore the role of banks, argues Emma Dawnay, Vollgeld campaign spokeswoman. The original supporters were often those interested in the environment, she says, or were struck by the fact that governments could not allow banks to go bankrupt. “They discover we have a financial system based on unsustainable growth in debt, punctuated with financial crises, and say ‘wow, how can it work like that?’”

Others proposing reforms to fractional reserve banking include Mervyn King, the former Bank of England governor, who has suggested an insurance scheme for banks. In exchange for a “premium”, the central bank would provide cash to banks if they faced liquidity problems.

But he believes it would be going too far to abolish fractional banking altogether because it allows necessary risk-taking in an economy — even if the process is not fully understood.

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