People rub their eyes abroad. Switzerland’s deposit protection system has characteristics that do not exist elsewhere. Those affected appear unimpressed.
Is my money safe in the bank? This question robs many people of sleep, especially in times of crisis. But there is an organization that is supposed to help such people get peaceful nights again. It is well hidden in an inconspicuous office building a stone’s throw from Basel train station and is called Esisuisse. The association only employs ten people and is not only one of the most important but also one of the most unknown institutions in the Swiss financial center.
100,000 francs are protected
The lack of awareness is surprising. Firstly, the organization is celebrating its 40th birthday this May. Secondly, it performs a task that is central to the stability of the banking system. Esisuisse is responsible for securing the deposits of bank customers. It must prevent savers from immediately panicking because of a rumor, withdrawing their money hastily and the bank concerned from falling into a downward spiral due to drying up liquidity.
Although Esisuisse rarely makes headlines, the institution is not without controversy. Especially abroad, people are amazed at their peculiarities. Organizations such as the International Monetary Fund (IMF) identify a need for reform. Whether rightly or not remains controversial. Some, including the Federal Council, say that the IMF does not understand the Swiss system. Others believe that the safety net here is quite leaky and actually poses a threat to financial stability.
Who is right? When looking for an answer, we recommend first looking at the basic principle: deposit insurance comes into play if a bank goes bankrupt. In this case, a balance of 100,000 francs per customer and banking relationship is protected against loss in Switzerland. Esisuisse must finance the payout of these secured customer funds. The 285 member banks are jointly liable for the money, depending on their secured deposits.
Harsh criticism of the IMF
This approach is undisputed. The dispute is unfolding elsewhere – and could soon get louder. The IMF is currently preparing to review Swiss deposit insurance. That brings back bad memories. In 2019, when the IMF last carried out a Financial Stability Assessment Program (FSAP) on Switzerland, there was strong criticism: The IMF wrote at the time: “Without thorough reform, deposit insurance cannot effectively contribute to financial security.”
These are harsh words. But the topic is gaining attention again. One reason is spring 2023. At that time, several regional banks in the USA stumbled, and in Switzerland, Credit Suisse, a globally systemically important bank, disappeared. Against this background, the “Banking Stability” expert commission set up by the federal government recently advised the authorities to also review strengthening deposit protection and to take international developments into account.
There are four peculiarities of the Swiss system in particular that are causing controversy, and not just among IMF inspectors:
1. A protection with a cap
Only a small part of the insured deposits is actually covered by deposit insurance. The reason is the upper limit fixed in the Swiss system. The total amount of secured assets at the end of 2022 was 504 billion francs. According to the banking law, the banks only have to make 1.6 percent of this available to Esisuisse, i.e. around 8 billion francs. There is therefore a huge gap between the officially secured deposits and the funds available from Esisuisse.
An upper limit is probably unavoidable. So it is unlikely that all banks will go under at the same time. The event of a loss by a big bank could also drag smaller institutions into the abyss if they had to stand in solidarity for the big bank’s deposits. But one problem remains: If a large bank or many medium-sized banks fail, the 8 billion francs won’t go anywhere. At the end of 2022, the secured deposits at eleven banks were above this limit.
However, the experts interviewed do not criticize the system cap per se; Similar limits exist in practically all countries. What is more problematic is that in Switzerland it is not clear what happens if the money financed by Esisuisse is not enough in the event of a loss. Nobody knows whether the customers of a medium-sized bank whose insured deposits are larger than 8 billion francs would still be protected against losses of up to 100,000 francs in the event of a collapse.
The IMF criticizes the fact that there is no state guarantee in Switzerland in cases where deposit protection reaches its limits. In the run-up to the banking law, which was adapted to the beginning of 2023, there was discussion about alternative financing, such as private insurance, borrowing from Esisuisse or a state solution through a guarantee or advance. However, these options were all rejected, either for cost reasons or because of fears of false incentives.
“The problem is not the upper limit, but the combination of this limit with the lack of alternative financing,” says an economist with professional insight into the system who wishes to remain anonymous. This combination could lead to people losing faith in the safety of deposits. “In a crisis, all it takes is a single critical media article about the upper limit and the bank run starts,” he fears. Other countries have therefore mostly defined financial solutions that go beyond their upper limits.
2. No pre-financed fund
The second criticism has to do with how Esisuisse gets its money. In many countries, such as the USA, deposit insurance can always rely on a fully pre-financed fund. In the crisis, Esisuisse, on the other hand, must first instruct its member banks to transfer money to the collapsed institution. But in times when a bank goes bankrupt, liquidity is often tight. There is a correspondingly high risk that the situation of the donor banks will also worsen.
Experts fear a pro-cyclical effect. This means: If the situation for banks is most likely already difficult, especially since financial crises rarely break out when the weather is nice, banks also have to make money available to struggling competitors. This can have a destabilizing effect on the financial system as a whole. The IMF is therefore pushing for ex-ante financing. The money should already be fully available when a bank fails.
Gregor Frey, CEO of Esisuisse, does not accept the criticism, for two reasons. Firstly, the Swiss system is unique worldwide. Every bank is obliged to hold domestic assets amounting to at least 125 percent of secured deposits. These assets would have to be unencumbered and easily usable. Added to this is the bankruptcy privilege. “Based on these rules, every bank should have enough funds so that the secured deposits can be paid out in the event of bankruptcy.”
Secondly, Frey refers to an innovation that has been in effect since 2023. For around a year now, banks have had to deposit half of the required financial contribution, i.e. 0.8 percent of their secured deposits, in advance, either as cash or in the form of easily usable securities. “In Switzerland too, half of the deposit insurance is secured through ex-ante financing,” says Frey. However, the other half must first be claimed from the banks if necessary.
3. A private association
Another peculiarity that meets with little understanding at the IMF: The Swiss deposit insurance is not backed by a state authority, but by a private association. When it was founded, it was also directly affiliated with the Swiss Bankers Association. Although that is no longer the case. Esisuisse is still based on the idea of self-regulation by banks. The IMF, on the other hand, calls for a public institution without bankers on the governing body.
It stands to reason that an association controlled by banks wants to keep the burden on the industry low. Its rejection of a fully pre-financed fund must be viewed against this background. Because if the banks had to advance the entire 8 billion francs, it would be more expensive than the status quo. But Esisuisse boss Frey replies: “Deposit insurance is regulated by the state. Although Esisuisse is organized as an association, it takes on some of the legal tasks.”
The idea of self-regulation has a long-standing tradition in Switzerland. In addition to advantages, this also has disadvantages. This makes it easier for government organizations to be involved in crises, for example in coordination with the central bank and banking supervisory authorities. An example: In South Korea, the national deposit insurance company has direct access to sensitive data such as the outflow of bank deposits in real time. You would hardly want to provide such data to an association that is managed by banks.
4. A pay box solution
The Swiss deposit insurance is purely a pay box. So it’s only there to pay out deposits when a bank is liquidated. In most countries, however, the skills are defined more broadly. Instead of simply paying out depositors, balances are transferred from one bank to another. Or, in the case of a systemically important bank that is already “too big to fail” and can therefore hardly be liquidated, the available funds can also be used for restructuring.
These four Swiss peculiarities go against the trend. Eva Hüpkes, Secretary General of the Basel-based International Association of Deposit Insurance Companies (Iadi), says: “The global trend is clearly towards systems with a pre-financed fund and with skills that go beyond the mere function of a pay box.” Iadi acts as a global umbrella organization and defines standards for its worldwide members, which also include Esisuisse.
Nevertheless, in Switzerland they seem to want to stick to the special model – much to the chagrin of the IMF. A year ago, in his country report on Switzerland, he expressed dissatisfaction with the adjustments introduced at the beginning of 2023, such as the partial pre-financing of deposit insurance. In a resigned tone, he wrote: “The authorities do not intend to revise the deposit insurance system as recommended.” That doesn’t sound like a convergence of positions.
The benefit of ambiguity
In defense of the Swiss model, one can argue that a certain amount of ambiguity can be disciplinary, for example in view of the unclear situation if Esisuisse’s money is not sufficient. Because if it is clear from the start that the state will eventually cover any shortfall anyway, customers hardly pay any attention to the solidity of the banks and simply take their money to where the highest interest rate is. Bankers could also feel compelled to be more careless.
Ultimately, deposit insurance is primarily intended for the bankruptcy of small banks. She is overwhelmed by big banks. In a country like Switzerland, where the sizes of banks are extremely unequal, the starting position is particularly difficult. The federal experts came to the conclusion in the fall that stronger deposit insurance would hardly have improved CS’s situation. The bank run there took place among very wealthy customers and primarily affected unsecured deposits. Even a very lavishly financed Esisuisse would not have changed much.