How Switzerland Saved Its Banking Industry

The Swiss faced one of the globe's worst financial-sector blowups. Now they're setting the gold standard for how to regulate their banks.

During the financial panic of 2008, the Swiss had more reason than most to be frightened. The country's banks, dominated by Credit Suisse and UBS, held assets worth an incredible 680 percent of Switzerland's GDP (compared with U.S. commercial banks' assets of 70 percent of GDP). No one knew how many of the Swiss holdings were toxic. What everyone knew was that these banks were far too big for tiny Switzerland to bail out in any full-blown banking crisis. Capital flight would crush the Swiss franc and the country's economy right along with it. There were scary parallels to Iceland, another small nation with an independent currency and outsize global banks. After a severe blowout, Iceland is now in a deep recession and on life support from the IMF.

Yet today, little Switzerland is a rock in the global tempest. The franc is one of the world's strongest reserve currencies, and both Credit Suisse and UBS are among the globe's most soundly capitalized big banks. Capital is flooding into the country and, yes, back into Swiss banks. It's a far cry from the U.S., where the Federal Reserve is still pumping money into a shaky banking and mortgage sector that shows few signs of healing. Or Germany, another epic victim of the global financial crisis, where politicians fight phantom speculators and each month seems to bring fresh news of previously undisclosed toxic-asset losses. And unlike many of the countries sharing the euro, there was never any worry that Switzerland would not be able to pay back its debts.

What did the Swiss do right? For one, the country's regulators and central bank were faster and tougher than most. During the lull in the summer before the collapse of Lehman Brothers in September 2008, the Swiss were hard at work on a plan to deal with troubled assets at UBS, the worst of Switzerland's problem banks—with a balance sheet more than four times the size of the entire Swiss economy. When disaster struck, the central bank swiftly nationalized part of UBS's assets and recapitalized the rest. That's unlike authorities elsewhere in Europe or Washington, who waited until the last minute to stitch together messy bailouts that left many problems to linger.

Second, the Swiss decided early on that tighter reins on their banks wouldn't just protect taxpayers from future crises and bailouts, but would ultimately be good for the banks' own business as well. With trust in the global financial system only slowly re-emerging, the perception that Swiss banks have to adhere to much tougher rules—and are therefore sounder—helps win the trust of Switzerland's most important customers: the global wealthy who let Swiss bankers manage their fortunes.

In just about every area, the Swiss are stricter. New plans pushed forward by the Swiss National Bank's ambitious 47-year-old chief, Philipp Hildebrand, will require UBS and Credit Suisse each to hold 19 percent of their total assets in capital to cover potential losses—almost three times the new global standard of 7 percent that will be phased in by 2019. Swiss banks are also required to hold more cash to prevent bank runs, and in 2009 were among the first to follow new guidelines regulating executive pay and bonuses—widely seen as an incentive to take excessive risks. Above all, Hildebrand has sworn that never again should taxpayers be held hostage to banks that are "too big to fail." To that effect, regulators have proposed new rules that would force banks to divide their business among separate units that could be liquidated in a crisis without sinking the mother ship—something that banks like Credit Suisse are already beginning to implement. Here, too, Switzerland is far ahead of the pack.

You'd think Hildebrand would be getting more credit for safeguarding Swiss banking's future. Instead, the Swiss business press has accused him of being internationally isolated. The Institute of International Finance, an organization that represents the world's largest banks, has repeatedly warned against individual countries "overreacting" to the financial crisis. Some countries worry that tough, Swiss-style rules will put their own banks at a disadvantage; for some of the weakest banks in Germany or the United Kingdom, new requirements to raise capital might require yet another infusion of taxpayer funds. Now that the crisis is starting to recede into memory, the pressure to regulate may weaken. Yet if the fast return to stability of the country's banks, economy, and currency is any lesson, the world could do worse than follow Switzerland's lead.