The Swiss National Bank’s decision to abandon its cap on the Swiss franc’s value against the euro last week threw the financial markets into chaos.
There are lots of theories as to why the central bank chose to act, but there is one that was clearly underappreciated — the role of Swiss local government in lobbying for dividend payments.
The SNB is unlike other central banks because it is not in fact owned by the Swiss government but is a listed company with shareholders that include Swiss administrative regions, know as cantons, as well other public bodies and private individuals. As Cullen Roche points us to:
At the end of 2013, 52.5% of these shares were held by cantons, cantonal banks and other public authorities and institutions. The remaining shares were in the possession of private individuals and legal entities in Switzerland and abroad.
Who owns the central bank is not terribly important. What is important is that the SNB has a fiduciary duty to its shareholders — that is, a responsibility to act in their best interest. And here we may start to understand the pressures that the bank was under.
Firstly, the SNB pays a dividend to its shareholders capped at a maximum of 6% of net profit as well as a flat fee to local governments. As such, shares in the bank tend to act very much in line with a Swiss government bond with a 6% coupon.
This arrangement provides a cool 1 billion francs ($US1.15 billion) annually split between Switzerland’s 26 cantons in proportion to their populations and, most importantly, was considered a safe and reliable stream of income. In fact, according to the Swiss central bank, the dividend had been paid every year for over 100 years. Until 2013. The reason? A collapse in the price of gold hurt the bank’s gold asset holdings.
The 30% drop gold prices over 2014 caused a loss of 9 billion francs, meaning that the central bank was unable to pay out under Article 31 of the Swiss National Bank Act.
The failure to pay a dividend proved a shock to local government finances — a fact that the central bank was clearly aware of. In its explanation for cancelling the 2013 dividend Jean Studer, President of the Bank Council, noted that the consistency of dividend payments reflected “special factors in the last two decades meant that payments were very handsome”. However, he reminded the cantons that “the SNB has regularly emphasised that there is no guarantee for the distributions“.
And yet after the cancellation the cantons started to complain to the central bank. Bloomberg reports that “cantonal budget chiefs earlier this month urged the SNB to give them more money for 2014 to offset shortfalls in revenue from other sources”. As majority shareholders in the business the bank had a duty to listen to but not necessarily to act on their concerns.
At the start of this month, the SNB said it expects to book a net profit of 38 billion francs for 2014 allowing it to restart its dividend payments. In its statement it made clear that as a result “ordinary profit distributions of CHF 1 billion to the Confederation and the cantons can be resumed”.
Yet less than a week later the central bank abandoned its currency peg, sending the franc soaring and providing the much publicised mark-to-market currency losses estimated to have been around 13% of GDP (CHF75 billion) on Thursday. Letting the franc appreciate against the euro means the value of euro assets that the central bank built up on its balance sheets (the euros that it bought to defend the cap) fall in CHF terms.
So why did they act in a way that almost guaranteed losses for the central bank’s balance sheet?
One simple (though incomplete) answer, is mis-timing. Given that SNB President Thomas Jordan believed that the franc was “greatly overvalued” at its pegged level it is perfectly possible (though it looked unlikely) that he thought it might fall somewhat against the euro after the peg was abandoned. At the very least he may have expected the rally to leave some of the SNB’s full-year profit intact — especially given that interest rates on deposits held at the bank were dropped even further into negative rates to dissuade people from shifting cash into the country — allowing the central bank to pay its dividend.
Even with the prospect of ECB quantitative easing weakening the euro the SNB board may have felt that having just dealt with the dividend payment for 2014 and with the rest of 2015 to try to reverse any possible losses it might incur after April, the central bank could seize the moment to abandon a peg that it had clearly become uncomfortable with. It has a whole year to find the money for the 2015 dividend, after all, even if it’s hurting right now as its foreign currency holdings sinking in price.
Of course, even if the franc had fallen against the euro initially such logic is effectively a gamble on the eurozone crisis. The European Central Bank (ECB) is widely expected to undertake quantitative easing on Thursday, the major impact of which may well be to weaken the euro further from its current level (and therefore potentially drive the franc up in the short-term). If it has a positive effect on the region’s prospects, then it is possible that eurozone growth will pick up, and with it the currency.
If it fails, however, the Swiss could find themselves taking in more capital flows from Europe seeking a “safe haven” place to park capital. You can see the SNB’s decision to drop its interest rate on deposits again to a staggering minus 0.75% — the bank takes a slice of your money rather than paying interesting — as an effort to limit this effect. Investors it seems still see the franc as a safe harbour from losses, even at a price of 0.75%.
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