Have regulations finally killed the secretive Swiss banking industry?
KYC and AML regulations and prosecutions threaten the very existence of Swiss banks either through the revocation of their licences or never ending compliance costs
The demise of BSI Bank at the hands of the Monetary Authority of Singapore and Swiss authorities marks the first time that failure to meet Know-Your-Client (“KYC”) and banker conduct principles became criminal offences that could result in personal liability and the revocation of a bank licence. Most importantly, it marks the ‘end of history’ for the Swiss banking industry.
An international investigation into 1Malaysia Development Bhd’s (1MDB) fallout marshalled enough investigative resources to collect a trail of evidence leading to BSI. The global money laundering and embezzlement investigations surrounding 1MDB involved US$4.2 billion of irregular transactions by the state fund.
While anti-money laundering charges and convictions have occurred before, KYC rules have been more about completing application forms. Not doing so truthfully or accurately have been somewhat difficult to enforce or criminalise. For the first time a gross failure or intentional inability to comply to KYC constitutes a criminal offence.
Ravi Menon, managing director of the Monetary Authority of Singapore stated: “BSI Bank is the worst case of control lapses and gross misconduct that we have seen in the Singapore financial sector. It is a stark reminder to all financial institutions to take their anti-money laundering responsibilities seriously.”
It is not the first time Singapore sent a banker to jail. In 1995, Nick Leeson pleaded guilty to two counts of “deceiving the bank’s auditors and of cheating the Singapore exchange,” including forging documents. He was sentenced to six and a half years in Changi Prison in Singapore and was released in 1999.
The Swiss Financial Market Supervisory Authority’s CEO Mark Branson was equally critical: “BSI ignored clear warning signals about the risk of some of its transactions as it pursued higher margin returns. BSI Bank was in serious breach of anti-money laundering rules and in violation of the principles of adequate risk management. Right up to top management level there was a lack of critical attitude needed to identify, limit and oversee the substantial legal and reputational risks inherent in the relationships.”
Compliance culture can easily fail because it can only be reformed and enforced by bankers themselves. Law enforcement and regulatory action can only occur after a violation has been committed. Compliance managers say that their main challenge isn’t just the complexity of the rules, but resistance from front line bankers trying to develop business.
The secretive, historical practices of the Swiss banking industry die hard in their culture. Absolute discretion, that is not knowing your client, and protecting secret bank accounts were once the envy of high-net-worth clients. They also drew the resentment of law enforcement agencies.
During the second world war, Swiss banks used their neutral jurisdiction for Nazi Germany to exchange hard currency when Reichsmarks were banned. This allowed the Nazis to pay for commodities and supplies to keep the Wehrmacht running. Post war, Switzerland carved out a place as a financial centre by adding many high-net-worth clients to its swelling list of loyal private banking clients.
London’s ‘Big Bang’ in 1985 usurped Zurich as a global banking centre. The 2008 financial crisis finally gave the US government a great opportunity to virtually militarise financial regulation. The Foreign Account Tax Compliance Act (FATCA) represented the first intrusive weapon of mass destruction of bank-client privacy.
In 2009, UBS paid a US$780 million fine to avoid prosecution for its role in helping clients evade taxes. Credit Suisse also paid a US$2.6 billion fine as part of a deferred prosecution agreement. Legal action over US tax fraud also undermined Wegelin, the oldest Swiss bank, which closed its doors in 2013 after 272 years of client service. Ironically, in 2015, BSI agreed to pay a US$211 million penalty to resolve a tax probe. The fine represented nearly three times its 2013 net profit.
Swiss banks are now facing extinction. KYC and AML regulations and prosecutions threaten their existence either through the revocation of their licences or never ending compliance costs. Only the two remaining universal Swiss banks, UBS and Credit Suisse, operate on a big enough scope and scale to have the hope to generate acceptable returns in a difficult and competitive landscape. Other Swiss banks must decide to exit the offshore private and commercial banking business.
The only remaining competitive advantage of Swiss banks is the implicit domestic advantage brought by the Swiss National Bank— in the absence of any required bail-in legislation (a significant edge over other euro zone banks) there is cheaper funding in Swiss francs. Lending in Swiss francs is the only sensible financial business that remains. And that ends Switzerland’s illustrious financial history.