For a bank, its interest rate is a reflection of its goals. If it wants to attract more depositors, it would increase the interest rates. Higher interest rates act as an incentive to save instead of spending, as there would be greater returns in the future. On the other hand, if it wants to loan out more money, it would reduce the interest rates. This suggests that there is little or no incentive for people to deposit their money in banks with low interest rates. However, this statement gets completely disregarded when it comes to Swiss Banks. Swiss banks are known to be a haven for foreign deposits despite offering really low interest rates. In 2017 for instance, money parked by Indians rose by 50% despite having a negative interest rate of -0.21%. This means that instead of earning interest, people were paying banks to keep their money.
This begs the question, why do people still keep their money in Swiss banks despite such low interest rates. This article tries to address this question by identifying factors that act as an incentive for people to overlook the low interest rates.
Swiss banks have developed a perennial reputation for privacy. Unless there are legal pursuits, they don’t reveal the customer’s identity. This reputation is courtesy of their Banking Law of 1934. Under article 47 of this law, it is considered a criminal offence to disclose any information about an account with a third party. It does not matter if it is tax authorities or foreign governments, unless you have permission from a Swiss judge, the details would never be disclosed.
However, if someone is found guilty of breaching the banking secrecy policy, they could be sanctioned a fine of up to 540,000 swiss francs(585,000 USD approx.) and a jail sentence of 3-5 years. This disincentivizes people from defaulting and along with a strict regulating body(Swiss Financial Market Supervisory Authority), bank employees tend to avoid any such acts.
Such strict privacy laws are one of the main reasons why people keep their money in Swiss banks. As movies like The Wolf of Wall Street display, this is a great way to hide undisclosed incomes. Since foreign regulatory bodies would have no jurisdiction in Switzerland, it becomes really difficult to track the money trail and people could stay safe behind those privacy policies. However, the benefits of these privacy laws are not just limited to such unlawful acts. Such policies come in handy for wealthy people to stay under the radar, as it helps them in avoiding jerry-built lawsuits, unwanted attention, etc. Further, such privacy policies also act as a shield against online frauds such as phishing, etc. Hence, such security does act as a great incentive, however, it is not the only reason why people prefer Swiss banks.
Return on investments
Even when the Swiss banks pay such low interest rates, they still manage to give great return on investments. This comes as a shock to most people; however, the secret lies in their low levels of inflations rates. In 2019, their average inflation rate compared to 2018 was 0.36%. In the same year, the average global inflation rate was 3.51% compared to previous year. This means that in 2019, the Swiss franc gained 3.15% in value compared to the average currency.
Such a low inflation rate was not a one-time thing for Switzerland. They have been experiencing a low inflation rate under 1% since 1994. In contrast to this, the global inflation rate has never dropped below 2%. This means that the value of franc has been increasing constantly since 1994. Though saving money in Swiss banks may not result in high interest earnings, still by saving for long periods, the value of the money does increase by a significant margin.
However, some may argue that such a return on investment does not pose enough opportunity cost for a foreign investor to direct their money into Swiss banks. To some extent, this argument holds. As for the USA, the average return on mutual funds for the last 15 years has been 5.89%. This is approximately double the return US investors would get if they keep their money in Swiss banks. In addition to that, mutual funds are a safer investment option than other investments(like equity), and so it makes more sense to invest rather than saving money.
However, there are two points to consider in this argument. For the last 20 years, inflation rates in the US have been around 2%. This means that the adjusted return on mutual funds was around 3.89%. This figure is not much greater than the return on saving money in Swiss banks. Further, investing in mutual funds, equity bear risks like stock market collapse, etc. Since there are no such risks with depositing money in Swiss banks, they are a much safer option than any other investment opportunities. However, this doesn’t mean that investors should keep all their money in the Swiss saving accounts. They should chase higher returns on other investment opportunities while keeping some money in deposit accounts as safekeeping. This would ensure a constant return to their wealth even in worst cases like market collapse.
Low levels of financial risks
Another reason why Swiss banks are way better than other banks is the low levels of financial risks in the nation. Switzerland has one of the most stable economies in the world with little or no inflation. Even during the Great Recession, when the global inflation rate was 8.89%, the inflation rate in Switzerland was at 2.43%. Such low levels of inflation rates thus allow a person to retain the purchasing power of their money by avoiding inflation in their own countries.
Further, Swiss laws demand banks to maintain a high capital adequacy ratio. This ratio reflect the minimum level of capital that a bank needs to keep against its risk-weighted assets. The higher the ratio, the greater the level of capital a bank is required to maintain. This implies that even in the rare case of a financial crisis, a person does not need to worry about their money as the bank could easily repay them with the capital it has kept as a safeguard. Under these laws, Swiss banks are supposed to maintain a capital adequacy ratio of at least 8%. This is exactly double of what US banks are demanded. Such high capital requirements, thus provide extra safety to keeping money in Swiss banks.
Furthermore, this safety also reflects in people’s trust in the bank. If they believe that their money is safe, they would be willing to keep it in the bank. The trust factor is another major reason for people choosing Swiss banks for their deposits. A high capital adequacy ratio along with a clean history of no major crisis acts as a huge incentive for depositing their money.
The presence of low interest rates does make Switzerland a poor choice for investments, however, its stable economy and undisputed privacy laws make it a great choice for saving uninvested money. Moreover, these low interest rates also have their benefits. By keeping money in Swiss banks, one would earn lower levels of interest and consequently, would pay a lower amount of tax on their interest income. By this, they could evade the high taxes that they would have been obliged to pay if they had deposited their money in their nation.
Though in the recent years after the Great Recession, several amendments were made in the Banking law of Switzerland. These amendments did make it a little easier for governments to get information about account holders, yet it did not dent the reputation of Swiss banks. Most of their privacy policies still exist and along with the strong economy, consumer’s trust and high ROI, the Swiss banking system is still considered to be one the best in the world.
Hemang is a Second-year student at Ashoka University majoring in Economics and Finance.