Switzerland is the biggest manager of offshore wealth in the world, with about a 27 percent share, according to the Boston Consulting Group's 2011 Global Wealth report. Clients fromGermany, Italy, Saudi Arabia, the U.S. and France make up about 42 percent of all offshore wealth managed in the country, the report said.
Should Switzerland abolish banking secrecy, it could risk losing as much as 700 billion francs ($768 billion) in the worst case, or about half of all money managed by Swiss banks on behalf of private clients not domiciled in the country, said Teodoro Cocca, a professor of wealth management at Johannes Kepler University in Linz, Austria. Such a shock would be enough to put the country into a recession, according to a study by Banu Simmons-Sueer at Zurich-based KOF Swiss Economic Institute.
Swiss Secrecy Besieged Makes Banks Fret World Money Lure Fading
Gianluca Colla/Bloomberg
A tram passes a UBS building in Zurich.
When UBS AG (UBSN) celebrated its 150th anniversary in Zurich last month with 600 guests dining on Ossetra caviar and Wagyu beef, there was no jubilation in the executives' speeches.
Trust "cannot be tied to a far-dated founding year; trust constantly has to be won anew," Chairman Kaspar Villiger told guests at the dinner prepared by Philippe Rochat, the Swiss chef whose restaurant is one of two in the country to earn three Michelin stars. "Reputation is the most important capital for a bank. It takes just a thoughtless action to lose it and the sweat of thousands to rebuild it."
Just about every UBS executive gathered in Hallenstadion, where sporting events, concerts and shareholder meetings are held, could relate to what Villiger was talking about. For almost three years he and former Chief Executive Officer Oswald Gruebel tried to rebuild the reputation of Switzerland's largest lender, damaged by a near bankruptcy in 2008 and the unprecedented delivery of data about affluent clients to the U.S. to avoid a criminal indictment.
UBS's image of solidity, based on conservative risk management and capital strength, was tarnished again last year when the Zurich-based bank discovered a $2.3 billion loss from unauthorized trading. Gruebel, 68, found himself a guest at the anniversary dinner rather than the host after he left his job in September. Villiger, 71, plans to step down in May.
Other guests included Marcel Ospel, who helped put UBS on the global map and whose ambitions in investment banking contributed to more than $57 billion in writedowns and losses related to mortgage-backed securities, and Eveline Widmer- Schlumpf, the Swiss minister who in 2008 had to bail out UBS.
Sullied Image
While the bank has recovered from near insolvency, its sullied image exemplifies a fall from grace of financial institutions that contributed almost one-third of the country's economic growth between 1990 and 2009. It's a transformation that resonates around the world as the banking industry struggles to overcome resentment for the excesses and opacity that led to the 2008 collapse of Lehman Brothers Holdings Inc.
Switzerland and its banks benefited from laws protecting secrecy. The inflow of foreign money seeking a haven in the country contributed for decades to lower interest rates, making borrowing and expansion cheaper for domestic companies and boosting household wealth. Now, what promises to be the biggest shake-up Swiss financial firms have seen in 80 years is bound to leave scars on the economy.
"The problem with any good thing is that it's too good to be true," Gruebel said in an interview this month. "If you have that for too long, there comes a day when it falls apart. And that's the case with bank secrecy."
'Historical Moment'
The pursuit of UBS by U.S. tax authorities has opened floodgates to attacks on other Swiss banks that threaten to tear down the bastion of secrecy. UBS and Credit Suisse Group AG (CSGN), the country's second-largest lender, also are facing stricter capital and liquidity rules forcing them to shrink more and faster than international rivals.
"It's a really historical moment," Tobias Straumann, a lecturer in economic history at Zurich University, said in a phone interview. "It's the first time that we have an open discussion on both of the issues. We had two external shocks: one economic and one political."
Switzerland Bleeding
The blows already are bleeding through to the economy. The banking industry's contribution to economic output in the country shrank to 6.7 percent in 2010 from 8.7 percent in 2007, according to Swiss Bankers Association data. That's still a bigger share of gross domestic product from banks than in the U.K. or the U.S. More than 40 percent of that comes from wealth management, making it the industry's most important business.
Switzerland is the biggest manager of offshore wealth in the world, with about a 27 percent share, according to the Boston Consulting Group's 2011 Global Wealth report. Clients from Germany, Italy, Saudi Arabia, the U.S. and France make up about 42 percent of all offshore wealth managed in the country, the report said.
Should Switzerland abolish banking secrecy, it could risk losing as much as 700 billion francs ($768 billion) in the worst case, or about half of all money managed by Swiss banks on behalf of private clients not domiciled in the country, said Teodoro Cocca, a professor of wealth management at Johannes Kepler University in Linz, Austria. Such a shock would be enough to put the country into a recession, according to a study by Banu Simmons-Sueer at Zurich-based KOF Swiss Economic Institute.
"Looking at the last 12 months, the likelihood of such a worst-case outcome has increased," Cocca said in a phone interview. "The attacks on Swiss banking secrecy and the actions of the Swiss government clearly go in one direction, and that is toward weakening of Swiss banking secrecy."
Tax Evasion
The government has been in talks for more than a year with U.S. authorities, who after getting data on about 4,700 UBS clients are now investigating 11 other banks, including Credit Suisse, for alleged assistance in tax evasion.
Wegelin & Co., a 270-year-old Swiss bank, had to sell itself to save its non-U.S. business before the U.S. indicted the firm last month. Philipp Hildebrand, head of the Swiss central bank, had to step down in January after information about his wife's foreign-exchange transactions was leaked by a Bank Sarasin & Cie. AG employee. Bank secrecy has become a point of mockery: A photograph in Neue Luzerner Zeitung featured a masked man at a carnival last month offering "cheap" Swiss client-account data on a compact disc as a "special offer."
'Island of Bliss'
The Swiss financial industry has prospered from others' misfortunes. Two world wars involving neighboring countries made neutral Switzerland a refuge for people concerned that their governments and currencies weren't stable.
Secrecy laws were enacted in 1934 after French police arrested top bankers of Basler Handelsbank in Paris in October 1932 for aiding tax evasion by the bank's high-profile French clients. Police confiscated a list of clients and later seized more money of tax evaders at other private banks in Geneva.
A run on Swiss banks that followed threatened their existence, and stopping the money flight became a priority, historian Peter Hug wrote in a chapter on banking secrecy in a 2002 book, "Memory, Money and Law."
"Switzerland got rich through black money," Sergio Ermotti, 51, who took over as CEO of UBS after Gruebel resigned, said in an interview with SonntagsBlick in October. "That will change in the future."
Offshore Money
The flow of offshore money into Switzerland helped reduce interest rates in the country by more than 1 percentage point, benefiting private and corporate borrowers, Villiger, a former Swiss finance minister, said at UBS's anniversary dinner. Switzerland still is seen as "an island of bliss" by observers abroad, Villiger said, adding that both the government and companies have to work hard to preserve that.
Hans J. Baer, whose family founded the Swiss private bank Julius Baer Group Ltd. (BAER), said in his 2004 book, "Be Embraced, Millions," that banking secrecy "makes us fat but impotent" as it places Swiss banks outside of general competition.
The fat from wealth management helped fuel the expansion of investment banking and the balance sheets of UBS and Credit Suisse, so-called universal banks able to use cheap funding to boost leverage and profitability. Between 1998, when UBS was created through the merger of Union Bank of Switzerland and Swiss Bank Corp., and 2006, the combined assets of the two banks more than doubled to 3.65 trillion francs, more than seven times Swiss GDP that year.
'Allergic to UBS'
That was followed by UBS's losses related to mortgage- backed securities and a government bailout providing 6 billion francs of capital to help the firm spin off $39 billion of risky assets into a central bank fund. Although the bailout was smaller than what other countries spent propping up their lenders, the realization that failure of a big bank could topple the country fueled a backlash against investment banking.
"In private wealth management, both the employees and the customers felt threatened by the investment banks because they thought we give the banks money and they turn around and use it for their own speculation," Peter Kurer, a former chairman of UBS, said in a phone interview.
Splitting off the investment banks -- undoing the universal model prized by global lenders including Citigroup Inc. (C) -- would help UBS and Credit Suisse regain the trust of shareholders and clients, Kurer has said.
Brand Damage
The negative image of investment banks in Switzerland remains strong, said Straumann, who wrote a report on UBS in the 2008 crisis. The loss from the unauthorized trading incident at UBS last year, which Straumann said could have happened at any bank, only added fuel to the fire.
"It's not rational anymore," Straumann said. "You just can't talk to people in a normal way when you talk about UBS. People are allergic to UBS."
Problems at home have taken a toll on the brands of UBS and Credit Suisse globally. UBS, which entered Interbrand's ranking of the world's top 100 brands at No. 45 in 2004 and rose to its highest ranking of 39 by 2007, slipped to 92nd last year. Credit Suisse entered the ranking at No. 80 in 2010 and fell to 82nd last year. JPMorgan Chase & Co. (JPM) rose from 30th in 2004 to 28th in 2011 and London-based HSBC Holdings Plc from 33rd to 32nd.
UBS and Credit Suisse also face capital requirements from Swiss regulators that go beyond demands on international rivals, making investment banking less profitable and pushing the banks to scale back. The firms said in November that they plan to shrink their total risk-weighted assets 33 percent to 270 billion francs and 23 percent to 285 billion francs, respectively, with most of the cuts in securities units.
'Too Big'
Gruebel, who has served as CEO of both banks, said they'll have to cut even more, to between 150 billion francs and 200 billion francs each, to be able to fulfill the new capital rules because retaining earnings won't be enough.
"To believe they can stay at 300 billion francs or more of risk-weighted assets over the next years is a dream," Gruebel said. "Both of their investment banks are too big today. The winner will be the one who will cut the most the quickest."
Credit Suisse said last month it has speeded up the reduction of assets and plans to reach the level targeted for the end of this year by the end of March. Still, the Zurich- based lender is six to 12 months behind UBS in restructuring and the performance of its investment bank is "extremely disappointing," Kian Abouhossein, a London-based analyst at JPMorgan, said in a Feb. 9 note.
Criminal Investigation
Credit Suisse, which had smaller writedowns from the subprime crisis than UBS, expanded its investment bank in 2010 to gain a bigger market share from competitors struggling with losses. The bank had added about 2,000 people to the securities unit since 2009 before announcing two rounds of job cuts last year. The expansion was wrong in retrospect, CEO Brady Dougan, 52, told SonntagsBlick in an interview last month.
The headcount at Credit Suisse's investment bank at the end of 2011 was 12 percent higher than at the end of 2006, while the unit's net revenue for the year was 44 percent lower than five years ago. UBS's investment bank cut staff by 21 percent over the same period as revenue slumped 56 percent.
Credit Suisse, unlike UBS, still faces a U.S. criminal investigation into tax evasion. UBS avoided prosecution in 2009 by admitting it aided tax evasion, paying $780 million and handing over data on 250 accounts. It later disclosed information on about 4,450 more. Credit Suisse is doing "everything" it can to help resolve the U.S. probe, Dougan said in an interview last month. The bank didn't take any clients from UBS as the latter was shutting down its business with Americans, he said.
UBS and Credit Suisse declined to make executives available to comment for this article.
White Money
Still, both firms are better prepared than smaller private banks for changes that may be coming with Switzerland's so- called white-money strategy of relying only on declared assets, Cocca said. UBS and Credit Suisse have through the years built out their onshore wealth-management businesses around the globe.
"Other players in Switzerland, some of the smaller banks, have a more backward-looking strategy," said Cocca. "They believe that they can stay a bit under the radar. Wegelin is an absolute clear example for that."
Wegelin, the St. Gallen-based private bank, last month became the first Swiss lender to face criminal charges in the U.S. crackdown on offshore firms suspected of abetting tax evasion. Wegelin helped Americans hide more than $1.2 billion in assets and evade taxes, wooing clients fleeing UBS, according to an indictment filed in federal court in New York.
The bank said last month it will "make every effort to resolve this matter within the boundaries of respectful cooperation with the U.S. and obedience to Swiss law."
Negotiation or Enforcement
While most private banks now say they accept only money declared to tax authorities, they disagree about how to make sure customers actually pay taxes, weakening Switzerland's position in negotiations with the U.S. and other countries, Cocca said. Kurer, UBS's general counsel and then chairman during the U.S. investigation, said talks with Washington probably will "drag on for a while."
Reaching an agreement on a governmental level, as Switzerland is trying to do, "will be extremely difficult because it will require on the American side also a view that this should be solved politically rather than by enforcement actions," Kurer said. "And I just don't see that."
The U.S. has successfully challenged Swiss banks before. In 1998, firms led by Credit Suisse and UBS reached a $1.25 billion settlement with Jewish groups that accused them of holding on to the assets of Holocaust victims. The accord came after U.S. local governments threatened to boycott the banks and divest Swiss investments. This century, countries including Germany and the U.K. also sought to pierce Swiss bank secrecy.
Information Exchange
Last year's agreements to collect taxes on money held by German and U.K. clients in Switzerland while keeping their identities secret are awaiting approval amid criticism by the European Union and Germany's Social Democratic Party opposition, which says the deals let tax evaders off too easy.
"The Europeans want automatic information exchange from us," UBS's Villiger said yesterday at an event organized by the Zurich Economics Society, referring to the collection of data by governments from financial institutions on income paid to non- residents for transmission to their countries of residence. "Actually, it's not very efficient."
People should be given time to legalize assets, some of which might have come from a long time ago, he said.
Asset Decline
Banks in Switzerland are "likely to experience a significant decline in assets owned by Western European clients" in the coming years, according to the Boston Consulting report. The German and U.K. deals alone may cause Swiss wealth managers to lose about 47 billion francs in assets, a study by consulting firm Booz & Co. said in November.
That's adding pressure on profit margins at private banks as managing offshore money has been more profitable and new rules are raising compliance costs. The Swiss regulator also is planning an overhaul of rules governing the sale of financial products to individuals after bank customers suffered billions of dollars of losses from Lehman Brothers structured notes and Bernard Madoff's fraud.
The average cost-to-income ratio of Swiss offshore private banks rose by 5 percentage points in 2010 to 72 percent, Boston Consulting said. In 2007, that ratio stood at 54 percent.
Tax Treaties
Implementing bilateral tax treaties may be more costly for many banks than agreeing to an automatic information exchange, which some politicians and bankers are advocating. In 20 years, Switzerland probably will have information exchange, Villiger said yesterday.
Meanwhile, with tax deals in flux and banking secrecy under attack, wealth managers must persuade clients that holding their money in Switzerland still has advantages. That will be challenging, Gruebel, the former CEO of UBS, said.
"How can we convince somebody outside of Switzerland to bring their money into Switzerland and pay taxes?" he said. "If we really want this white-money strategy, we have to come up with something which is cleverer than anything else in the world. And we don't have much time to figure it out."
To contact the reporter on this story: Elena Logutenkova in Zurich atelogutenkova@bloomberg.net
To contact the editor responsible for this story: Frank Connelly atfconnelly@bloomberg.net
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