The Swiss government has started to consult the country’s financial industry on how to protect savers in banks by deposit protection measures, a move that would represent a significant development for the banking sector.  

The Swiss Federal Council said it plans to secure bank deposits with a two-stage system, financed by the banks themselves.

This draft is a fundamental change from previous Swiss practice. So far, all banks had to provide the capital for deposits of a defaulted bank after the bank went bust.

This system could work well when a small bank goes bust, but the banking crisis showed that major banks too could face the danger of defaulting.

In such case, the legal requirement for other banks to provide the missing money could cause further problems to previously health banks, especially in a crisis like the one we witnessed throughout the last 12 months. The new system is expected to heal this problem, by building up a fund in good times and having the money ready for bad times.

Switzerland, like many other countries affected by the global financial turmoil, has seen a number of its banks hit by heavy losses, with the most spectacular hitting UBS. In countries such as the UK, for example, governments have extended deposit protection cover.

Under the two-stage process suggested by the Swiss government, stage one would involve a public-law fund of about SFr9.75 billion ($9.43 billion), set up to secure bank deposits. This fund will be put into place by the banks themselves. They will make annual payments towards two thirds of the amount needed. The other third will be secured through hypothecation of securities.

The fund is expected to have the capital ready within 20 days after the case of a default of a bank to pay back the customers. Under certain circumstances, some of the fund's capital may also be used to continue operating important services of the defaulted institution. The regulations would be put into place through a gradual, long-term transition period.

In case the fund would run out of money, a second stage of the draft proposals offer two different alternatives: a federal advance payment by the Swiss government and a federal guarantee.

As a result, if an advance federal payment is chosen, all Swiss banks would have to repay the capital used through annual payments. In the option of a guarantee, the Swiss taxpayers would have to provide the capital.

Diana Beti, vice-director of the federal Swiss Finance Department, told WealthBriefing that stage one of this blueprint is a copy of the American system and, together with stage two, will provide Switzerland with a modern system of deposit security.

When consensus on this legislation has been reached, the Federal Council will submit a draft to the Federal Assembly of Switzerland, the Swiss parliament, which will have the last word on this matter. The consultation process will run until 31 December 2009.

Already on 20 December last year, the Swiss Parliament decided that an urgent change of banking deposit legislation was needed to react to the international financial crisis.