The Swiss government plans new legislation to end the danger that banks deemed “too big to fail” may cause to the economy. The Federal Council wants to “quickly and effectively limit the risks for the national economy caused by large, systemically important banks”, it said in a statement.

This will include more stringent capital, liquidity and risk diversification requirements.

Aware of the fact that the insolvency of the country’s big banks would have a disastrous impact on the Swiss economy, the Federal Council approved a corresponding planning resolution for the planning of a revision of the Swiss Banking Act. The changes could come into force by 2012.

“Systemically important financial institutions provide key services for the Swiss economy that could not readily be assumed by other providers,” the Federal Council said. The financial sector in the Alpine nation contributes to about 11 per cent of its economic performance. The failure of financial institutions could therefore cause “functions that are of the utmost importance for the economy” to cease to exist.

Such an event may force the state to rescue the troubled institutions, as seen during the financial crisis in which even UBS had to receive state aid, being deemed too big to fail. As a result, it is argued by some commentators that such bailouts encourage banks to become complacent if they believe they will always be able to rely on the taxpayer - what is known as a "moral hazard" problem.

To prevent this from happening again, the Federal Council believes legislation is necessary. It said that within the government there is a political will to resolve this problem “swiftly and effectively”.

“The risks of systemically important banks should be restricted, as more stringent capital, liquidity and risk diversification requirements will be set out in the Banking Act.”

Further, it should be ensured that systemically important functions at a troubled financial institution are maintained without an entire institution having to be rescued by the state, the Federal Council said in a statement.

There will be a consultation on the proposed measures in October this year. The Federal Council will then ask parliament to adopt it. If all goes swiftly, the legislative amendments may come into force on 1 January 2012.

In related news, the Federal Council will submit a consultation draft on bonuses in autumn 2010. This draft will state that compensation in financial institutions that are receiving government assistance should be restricted by law. In addition, it states that company profit-based variable salary components should be classed as profit distribution.