When it comes to the Swiss financial industry, there is an elephant in the room. No one wants to admit it is there, let alone confront it. But it is slowly suffocating the industry in a country of great history, talent and potential. I’m talking about the fact that the Swiss financial system need to be restructured. I believe the financial services industry is groaning under the weight of its two largest banks, UBS and Credit Suisse.
These two large banks have gummed up the works. They suck up much of the industry’s entrepreneurial and creative talent, leaving the industry in a constant crisis and unable to respond to the challenges of the day. I’m worried what might happen if we don’t free up the industry. How will we remain competitive? I am not here to simply criticize, I am here today to open the conversation — perhaps the most important conversation the industry has had for a while.
Who am I to talk?
Now, some background about me. Six years ago, my wife and I had lunch with Warren Buffett. At the time, we lived in New York. That lunch convinced me that we needed to move away. We considered a number of different cities, but ultimately, we chose Zurich and I brought my investment business here. I write about this in my recent book, The Education of a Value Investor.
There are many reasons we chose Zurich. But a major part was that I was attracted to the values upon which Swiss society is built — independence, respect for the individual and a sense of «klein, aber fein,» which I’ll translate as «small but mighty.» They epitomize the values that Warren Buffett and Berkshire Hathaway have taught me.
For example, consider the concept of «Margin of Safety» taught by Ben Graham: We see that all around us in Switzerland in so many ways — in the Swiss construction of tunnels and bridges and in the construction of many Swiss balance sheets. Buffett’s partner Charlie Munger has talked about doing business within a «web of deserved trust.» Well, Switzerland, and Zurich in particular, epitomize that. Where else in the world can you go to a restaurant, or a shop, forget your wallet and have the salesperson say «just come back and pay tomorrow.» In Switzerland, that is a daily occurrence.
But five years later, it becomes increasingly clear to me that when it comes to financial services and banking, all is not right. Or perhaps I should use the most damning phrase that one can use in Switzerland: «Es funktioniert nicht.» I am an investor, not an academic, or a consultant. Financial services is not even my specialty. But as an investor, I believe I have trained my ability to arrive at conclusions about what is likely to be true, in spite of incomplete information. You should also know that I am not an activist investor. I don’t own a position in any company within the Swiss financial sector, nor to I plan to take a position. My perspective is simply that of a financial market participant, a concerned resident of Switzerland and an investor who strongly believes in the Swiss Financial Industry.
Back to banking
Let’s start with the history of Swiss banking secrecy. There is no question that privacy and discretion are very important Swiss values. They are the core of what it means to be Swiss. Many believe that Swiss banking secrecy was ripped apart by more powerful countries like the United States and Germany. Lets get rid of that misperception. The loss of Swiss banking secrecy has little to do with those countries, which have always been more powerful than Switzerland. The loss of Swiss banking secrecy has everything to do with the technology and the Internet. As Stewart Brand, the founder of the Whole Earth Catalog said, «Information wants to be free».
I find it both surprising and alarming that Switzerland, a pragmatic country, has continued to blame the US and Germany for this loss, rather than deal with it in a practical manner. Lets move on to the tax evasion issues with the US. Just to be clear, I have no rose-colored glasses for the United States, which itself is a massive haven, perhaps larger than Switzerland for flight money. None of the Latin American countries, whose entrepreneurs are using the American banking system, often in Miami, have the ability to weigh in on American practices, the way the United States weighs in and gets civil and even criminal convictions on Swiss practices.
Again, I find it surprising and alarming that Switzerland, a practical and pragmatic country, and its banks, has not dealt with these issues better. When I try to understand why, it is clear to me that much of the blame falls on the two largest Swiss banks.
Too big to manage?
Here is the problem: Someone, somewhere seems wedded to the idea of Switzerland being the home of not one, but two large universal, Swiss banks, bearing the Swiss national brand (they both have Swiss in their names). As banks, they are in a whole range of businesses. For Americans, «Swiss and Chocolate», or «Swiss and Watch», or «Swiss and Precision» has a positive connotation. Yet the words «Swiss and Bank» are highly negative. Like it or not, the images in many American minds range from Nazi gold to the expropriation of Jews and tax evasion.
Speaking as a businessman, we have a brand issue here. To most effective business people and decision makers, when your brand is giving you a problem, the thing to do would be to reduce it’s profile. But instead, it seems to me that the Swiss banks have doubled down, extending their brand. In so doing they have made themselves even bigger targets for fines and regulatory action that stymie their whole organizations.
Moreover, the banks are so large that they dominate the local scene. In economic terms, they crowd out resources that might flow to other institutions and businesses. For example, much Swiss financial talent flows into those institutions and that makes it hard for other businesses to grow. Similarly, the two firms are so large that they dominate Finma. Does anybody truly think that Finma regulates the two large banks in the same way that they regulate everybody else? And when it comes to Swiss politics they dominate in Bern. The result is that the rest of the industry bears more than it’s fair share of the brunt of the average Swiss citizen’s frustration with the financial industry’s bad name.
Internally, the banks are, in a kind of spasm. They have been beset by so many problems: the financial crisis, large losses, the end of banking secrecy, charges of tax evasion, new capital requirements. The result is that as organizations they have been unable to adapt in a productive way. And that is why issues like the loss of banking secrecy, or the tax issues with the United States, are taking so long to resolve.
A new model for the Swiss financial industry
What’s the solution? My model for a bright future of a thriving Swiss banking industry would be one where, at least for international clients, Swiss Banking secrecy is over. And acting as a haven for flight money is also over. My model for Swiss financial services would emulate the model of Boston or perhaps San Francisco. Those two cities are leading financial centers that, in spite of their small size, more than hold their own against New York, not to mention Chicago and Los Angeles.
How do they do it? They have no advantages when it comes to secrecy or flight money. They do it by being an operating base for many extremely specialized financial institutions. Boston is not the home to one single universal, or money center bank. New York City is the center par-excellence for those, hosting banks like JP Morgan, Citigroup, Bank of America and the like.
Boston is a center of excellence for professional investment management. Firms like Fidelity Investments, Putnam Investments and a whole host of smaller, but highly professional and top-performing investment management firms are based in Boston. When I looked at the largest bank in Boston, the answer was telling. It was State Street. For those of you who don’t know, State Street is a highly specialized sort of bank, also known as a custodial bank. It specializes in the custody and administration of assets for professional investors.
When I look at San Francisco, it’s a similar picture. Wells Fargo is headquartered there. But of all the American large banks, it is the least universal, focusing primarily on traditional deposit taking and lending. Other than Wells, San Francisco, like Boston, has some interesting and specialized financial businesses. Dodge and Cox, like Putnam, is a specialized investment manager. The area also has businesses like Charles Schwab — a discount brokerage and wealth manager. There are even more specialized ones like Fair Isaac, which develops credit ratings for individuals across the country and is responsible for the well-known FICO score. Or Advent Software that does accounting for funds like mine.
Returning to Switzerland, it’s not like the country does not have some specialized institutions. Six Group, and the European operations of Interactive Brokers. But it has far too few. I think that this is a shame. Zurich should have a bank like State Street, or Bank of New York, specializing in custody and administration. The values required to make those businesses successful are all things the Swiss do well: Trust, precision, reliability.
Peter Kurer, former chairman of UBS, has argued that it is just a matter of time before the two largest banks break up. In general, he’s referring to a separation of investment banking from consumer operations, but I don’t think this goes anywhere near far enough. My hunch is that, buried within the two largest banks, there are a whole host of businesses that could be highly competitive in their own right.
A vision of the future
What we need is a fundamental rethinking and restructuring of the whole industry. I don’t have the knowledge, or the resources to paint the whole picture, or to get it right. But I find it disappointing that the industry is not leading. I imagine a future Swiss financial industry where standards for precision, reliability and trust are set by a highly specialized Mittelstand of financial firms that are part of the guts of the world’s financial system. There would be Swiss equivalents to companies like Advent Software, Fair Isaac, State Street and others.
I have no doubt that the seeds of a whole host of world beating financial industry participates already exist. To give you a sense, imagine that Credit Suisse and UBS were to combine their global custody operations to create a Swiss rival to Citibank, HBSC, State Street, Bank of New York and other leading global custodians. Then, imagine they merged and spun out their internal fund accounting and administration. It would become a Swiss rival to the leading fund administrators, like Citco and SS&C. Lastly, imagine the banks have spun off wealth management divisions into separate boutiques. They could still use globally competitive and merged common services. These firms would be the Swiss equivalents to Putnam and others. The important point here is not whether the banks should split wealth management from other divisions.
Leadership is needed
As long as the leading firms simply look for incremental solutions, as long as all they do is respond within the existing paradigm, the Swiss financial industry will be mired in the old and worn out problems that I have already mentioned. What is needed are some real leaders at the top, executives who can fundamentally rethink the value chain and break apart the two behemoths that sit at the top of it.
Although I am uncertain of the exact structure of the industry that will make the future bright, there is one thing that I am very certain of: There is an enormous amount of talent available to make it happen. This potential is currently buried in bureaucracy. It is waiting to be unleashed.