The Swiss National Bank lacks transparency in the handling of its loss provisions and distribution reserves. Clear rules for the distributions of SNB profits to the Swiss Confederation and the cantons are needed.
Over the last decade, profits of the Swiss National Bank (SNB) have increased strongly. This is not surprising as its balance sheet has exploded in size. However, the share of the profits distributed to the Confederation and to the cantons of Switzerland has declined. In fact, since 2005 the SNB has distributed only about one third of its profits and retained the rest as equity.
The SNB’s profits and profit distribution have triggered a vibrant public debate. That is a good thing – public debate is one way of keeping central banks and other policy makers accountable and thus makes for better policy. We in the SNB Observatory decided to study these issues and are today releasing a report on the SNB’s profit distribution to further the public debate. The report is available here.
The bulk of the SNB’s profits comes from its foreign investments, which have accumulated as the result of its foreign exchange market interventions. These interventions aim to prevent an excessive strengthening of the franc and deflation in Switzerland. They are thus a side effect of its monetary policy.
The SNB’s investments naturally yield returns which grow with their size. However, they are risky since their value in francs fluctuates with the exchange rate. Since the investments are partially held in equities, fluctuations in equity prices also impact their value. Consequently, their value is highly sensitive to foreign exchange rates and to stock prices, and there is a risk that the SNB may experience large losses from time to time.
To deal with such losses, the SNB sets aside a predetermined amount for provisions. These provisions are large, about 87 billion francs or 9.4% of its huge foreign currency investments. Given the riskiness of its portfolio, this seems appropriate.
The SNB sets aside another part of its profits for reserves for future distribution. It is required by law to smooth the amount that it distributes annually to the Confederation and cantons. To that effect, it maintains a distribution reserve. The provisions for foreign investments and the reserves for distribution make up the bulk of the SNB’s equity.
While these procedures are appropriate, the way in which they are implemented raises several important questions.
First, the SNB decides on the size of its provisions for foreign investments without any economic justification. The risk on its balance sheet depends on the size of its foreign investments and on their allocation to bonds versus equities. One would therefore expect the rule for establishing provisions to be explicitly related to these factors, as is the case for financial institutions.
But it is not. Instead, the provisions grow on autopilot by at least 8% per year, and even 10% in 2020. This process is clearly not sustainable. If the provisions for foreign investments continue to grow at such a rate, they stand to eventually become larger than the foreign investments themselves.
Moreover, while the provisions appear broadly appropriate now, it is not clear whether they need to grow further, unless the balance sheet continues to grow. The SNB should provide more transparency about the provisioning process.
Second, while the large provisions are necessary to absorb valuation losses, they are not used for that purpose. Instead, the occasional valuation losses are ascribed to the distribution reserve. Importantly, the funds set aside for these provisions are explicitly excluded from future distribution.
It is difficult to justify large and continuously growing provisions if they are never used, and it is disturbing that about a third of profits are simply «for keeps».
Third, the distribution reserves are exceptionally large, about 15 times the 6 billion francs that were distributed in 2021. This is far too much by any standard. The reserves for distribution should fluctuate over time as the SNB absorbs its variable profits to smooth the amounts that it distributes. The reserves should not keep growing year in, year out, as they have done.
Of course, the SNB needs to have enough equity to meet possible large losses, largely a consequence of the safe haven status of the franc. But this requirement does not justify continuous rises in equity. We estimate that the current level of equity is excessive and that it reduces the profit distribution to the Confederation and cantons for no given reason.
The SNB should come clear about how much is necessary and how it has made that judgement.
In our report we suggest a few changes that will make the process both more logical and sustainable.
First, the SNB should use the provisions for foreign investments to cover losses when they occur. And provisions should be replenished promptly with profits when they subsequently occur.
Second, the SNB should determine a target ratio of provisions-to-balance sheet or provisions-to-foreign investments, beyond which provisions should not be accumulated. We expect that calculation to lead to provisions of about 10% of the balance sheet – which is about the current level.
Finally, it should adopt a distribution rule that ensures that all profits are distributed over the medium term. A simple way to achieve this is to distribute annually the average distributable profit over the previous few, say five, years.
In our report we rerun history under our proposed rules. Not surprisingly, under our assumptions over the period of 2007 to 2020 the SNB would have paid about four times as much in profits to the Confederation and the cantons as it actually did.
The flip side of the coin is that larger distributions mean that the distribution reserve is lower, increasing the risk that in years of losses no profits would be paid. In our case, this would have been the case just twice in this time period considered, as opposed to once under the SNB actual rules.
This article is co-authored by Stefan Gerlach (Chef Economist at EFG Bank), Yvan Lengwiler (Professor of Economics at University of Basel) and Charles Wyplosz (Professor Emeritus of Economics at The Graduate Institute, Geneva). They are the founders of the SNB Observatory.