thomas j jordan : approaching the finishing line – the too big to fail project in switzerland speech by mr thomas j jordan, vice chairman of the governing board of the swiss national bank, at the international center for monetary and banking studies, geneva, 17 may 2011. * * * i would like to thank dr. claudia strub and till ebner for their valuable support in drafting this speech. introduction eighteen months ago, we here in switzerland tackled a major challenge : the search for a solution to what is known as the “ too big to fail ” problem in the current financial system. “ too big to fail ” means that the state has no choice but to rescue a company because its demise would seriously affect the entire economy. in good swiss tradition, a broad - based committee of experts1 presented the federal council with a proposal supported by all involved parties and the implementation of which would significantly alleviate the “ too big to fail ” problem. this proposal was, in essence, approved by the federal council and has been put before parliament in the form of a draft law. at this point, i should like to deliver an important message. the package of tbtf – too big to fail – measures is not intended to hurt the big banks or the banking sector in switzerland. rather, it aims to protect state and taxpayer from incurring an unwanted and unacceptable risk, while also creating the necessary framework conditions for the banking sector to be able to develop sustainably and successfully over the long term. the decision is now up to the politicians. in the coming weeks and months, parliament will decide whether the proposed measures will actually be implemented. the final, decisive phase of the project is thus underway – we are approaching the finish line! in the swiss system of direct democracy, the electorate essentially also has the final word in the legislative process. it is therefore important to ensure that the public clearly understands such a complex topic as the regulation of systemically important financial institutions. the snb has the statutory mandate to contribute to the stability of the financial system. it thus played a significant role in drafting the solution put before the federal council. allow me to explain the considerations behind the proposed legislation. the cost of financial crises the latest crisis highlighted the fact that big, globally interconnected financial institutions present a particularly large risk to an economy. if they fail, systemically important functions vital to the smooth running of the economy – such as the lending business or executing payment systems – can no longer be carried out. it is for this

nominal long - term interest rates, it is useful to think of them as the sum of two elements, the real long - term interest rate and the inflation premium. economic theory tells us that the real interest rate is the price that matches the supply of savings with the demand for capital used for investment. supply and demand for funds, in turn, are determined by fundamental economic factors such as the time preference of households to consume today relative to consuming tomorrow, as well as the productivity of capital and demographic factors which determine future growth prospects. to arrive at market - quoted nominal interest rates, one must add to the real rate an inflation premium, which compensates the investor for the potential loss in the purchasing power of money over the term of the security. bis central bankers ’ speeches so, to shed light on the movement towards lower nominal interest rates since the 1980s, let us examine how these two components – the real interest rate and the inflation premium – have changed over that period. a secular downward shift a considerable part of the secular decline in nominal rates is the result of lower and more stable inflation rates in advanced economies, translating into reduced inflation expectations and a lower inflation premium ( chart 2 ). reduced volatility of inflation rates since the mid1980s – a development associated with the “ great moderation ” – has probably contributed to this. 1 this reduction in the inflation premium and in volatility can, at least partly, be attributed to the success of central banks ’ policies and their credible commitment to low and stable inflation, a commitment which has become the hallmark of modern central banking. realised real rates – calculated as observed nominal rates minus the realised inflation rates – have also declined, and have been substantially lower in the 2000s than in the 1980s ( chart 3 ). there are several potential explanations for this development. a first explanation is the “ global savings glut ” hypothesis, which states that the decline in real interest rates was the result of an increase in savings from emerging economies and oilproducing economies. it is argued that this increase was driven by, among other things, an accumulation of foreign exchange reserves, elevated oil prices and precautionary savings ( chart 4 ). 2 but the decline in real rates could also result from a decrease in growth prospects – itself caused, for instance, by a decline in the growth of productivity or population, or by demographic shifts, particularly a reduction in the working population relative to the nonworking population ( charts 5 and 6 ). 3 none