The dust stirred by the Swiss National Bank’s (SNB) decision last Thursday has settled. The actors in the money and foreign exchange markets have quickly absorbed the quarter-percentage-point cut in the key interest rate: The franc has weakened against the euro, but only slightly, as the step was not entirely unexpected given the uncertainty ahead of the early elections in France.

Economists and strategists from banks have analyzed and commented on the decision, and—more important for the future than for dealing with the past—have adjusted their interest rate and other financial market forecasts. The media has largely ticked off its coverage of the monetary policy assessment. After all, the impact of a quarter-percentage-point cut on the long-term prosperity of the Swiss economy and financial center is likely to remain somewhat manageable.

Uncommunicative SNB

Besides the interest rate decision, the media focused on the demands made by the SNB during the presentation of the Financial Stability Report regarding the reform of banking regulation, with particular interest in the future desired level of equity in the balance sheet of the last Swiss major bank, UBS.

However, when it comes to its own balance sheet, the SNB appears to feel less need to communicate. As a reminder, the total of the central bank balance sheet is still around 850 billion swiss francs, significantly more than the gross domestic product, i.e., the value added of the entire Swiss economy in a year (which is expected to be in the order of  800 billion swiss francs in 2023).

Below the 1 Trillion  Swiss francs Threshold

At least the SNB’s balance sheet total today no longer breaks the psychologically significant 1 trillion mark swiss francs, as was occasionally the case in 2021 and 2022; however, the value has increased slightly again this year. And since 2019, when then Finance Minister Ueli Maurer publicly expressed his discomfort with the balance sheet growth, the SNB has been spared federal criticism.

The massive central bank balance sheet, even by international standards, is a legacy of the financial crisis. Previously, the balance sheet value oscillated around 100 billion swiss francs for years. The enormous foreign exchange purchases, with which the SNB implemented its monetary policy from 2009 (before, during, and after the minimum exchange rate regime of 1,20 swiss francs per euro from September 2011 to January 2015) in the fight against the appreciation of the national currency, led to a rapid balance sheet growth.

A Legacy of the Financial Crisis and the Fight Against the Strong Franc

Foreign exchange holdings are by far the largest item on the asset side. Holdings because the SNB holds foreign exchange not in cash but in the form of bonds and stocks in foreign currencies. At the end of 2023, they amounted to around 670 billion swiss francs, with a balance sheet total of just under 800 billion swiss francs, associated with correspondingly high valuation risks (markets, interest rates, exchange rates).

Gold reserves ranked second, albeit significantly lower, weighing in at just under 60 billion swiss francs at the end of the year, and secured loans ranked third at 40 billion swiss francs. These loans were used by the SNB to refinance banks favorably for COVID-19 aid (when banks were part of the solution to a problem) and to support Credit Suisse in its crisis (when the major bank itself was the problem).

SNB Wants to Increase Equity Further

Since the SNB acquired foreign exchange from banks with newly created francs, domestic banks' sight deposits (450 billion swiss francs) dominate the liability side (usually bearing interest at the SNB's key rate). This is followed by liabilities from the SNB's own debt securities (SNB Bills) and repo transactions (87 billion and 63 billion swiss francs, respectively). With these two monetary policy instruments, the SNB can implement its monetary policy in the money market despite high excess liquidity, i.e., bringing the short-term market interest rate close to its key rate. With its own funds of around 63 billion swiss francs, the SNB achieved an equity ratio of about 8 percent by the end of the year.

The SNB regularly emphasizes that it aims for a robust balance sheet with sufficient equity to absorb significant losses. Therefore, since 2009, allocations to reserves have been gradually increased. The reserves represent the target level of equity and stood at 105 billion swiss francs at the end of 2023, significantly above the actual amount. Hence, there was a 40 billion swiss francs gap in the so-called distribution reserve, effectively a balancing position.

Where is the Optimal Balance Sheet Size?

While the monetary authorities have a fairly clear course regarding equity, the SNB has not provided indications of the desired long-term balance sheet size and associated risks. There is a good reason for this: The balance sheet and its composition are largely determined by monetary policy decisions and their implementation. If the SNB were to commit to a specific target size today, it could potentially limit its future monetary policy flexibility.

In a time when monetary policy is navigating without clear guidance, this is a particularly valid argument. Moreover, it is not entirely clear in today’s environment how an interest rate decision will impact the balance sheet. For example, the recent rate cut could make it easier for the SNB to forgo further foreign exchange purchases and thus avoid balance sheet expansion. On the other hand, a franc depreciation induced by the cut means that foreign exchange holdings are inevitably valued higher, extending the balance sheet accordingly.

Even the Central Bank's Balance Sheet Has Limits

Nevertheless, more transparency regarding the future balance sheet size would be desirable and not entirely impossible. Those seeking somewhat reliable hints from the SNB must look relatively far back and will find a reference in a speech given by the departing (and therefore perhaps somewhat more candid) vice president of the board in May 2015, a few months after the abrupt abolition of the minimum exchange rate.

Jean-Pierre Danthine described the belief that a central bank could expand its balance sheet without risks and thus without limits as fiction. «This fiction contradicts common sense and is mainly found in academic circles,» criticized the vice president, who is himself quite academically adept.

Larger Balance Sheet Today, Less Room for Maneuver Tomorrow

The central bank balance sheet can never be a goal in itself, but the risks and costs of balance sheet expansion must be considered in monetary policy. Danthine defended the abolition of the minimum exchange rate with the argument that continuing it would have meant a «permanent, possibly uncontrollable expansion of the SNB balance sheet.» This would have massively increased the risks associated with such a policy, and the monetary policy risks associated with future normalization would have been significant.

«A monetary policy normalization in the future will inevitably require the reduction of excess liquidity to contain potential inflation risks.» Danthine was notably concerned about a balance sheet that was «only» 90 percent of GDP. «Balance sheet expansions always limit the SNB’s future room for maneuver because they raise the bar for further use of the balance sheet for monetary policy purposes.»

A Case for Jordan?

Now that the dust has settled, the elephant, the SNB balance sheet, is more visible again. President Thomas Jordan, who will leave the SNB board at the end of September, dedicated his last speech in late May in Korea to the neutral interest rate as a reference point for monetary policy, undoubtedly an important issue.

Currently, no further appearances by Jordan are scheduled on the SNB's calendar. However, should he plan to deliver a final speech in Switzerland, the significantly grown balance sheet during his tenure and the corresponding implications for monetary policy would be an ideal topic.