By Deborah Ball
While the spotlight has been on the aggressive drive by the U.S. government to flush tax dodgers out of Switzerland, bankers here are instead grappling with the loss of a much richer clientele: Europeans.
Americans have made up no more than 5% of Switzerland's $1.8 trillion offshore-banking business. But European clients are steadily coming clean, spooked by threats of a crackdown by their own governments.
Nonresident, or offshore, clients make up about a third of Switzerland's private-banking business, with just more than half of those coming from other European countries. According to KPMG, as much as 80% of the Europeans' money in Switzerland is undeclared. In all, KPMG reckons that tax evasion could represent up to 25% of Switzerland's total private-banking market.
This weekend, Swiss banking giant UB S AG will hand over the names of 500 suspected American tax dodgers to the Internal Revenue Service, the first of 4,450 names it will turn over as part of an August agreement between the U.S. and Swiss governments. That accord marked a historic breach of Switzerland's cherished bank secrecy, and prodded many Swiss banks to refuse to take American clients for fear of falling foul of U.S. laws.
Now, in the wake of the American crackdown, and Switzerland's cooperation, an exodus of European money is under way. According to consulting group McKinsey & Co., Western European money makes up 51% of legacy assets in Switzerland, but only about a third of new money.
"It's a big mistake to say this is an American issue," says Philip Marcovici, a Zurich partner at law firm Baker & McKenzie. "The Europeans are right around the corner."
To be sure, the demise of the tax-dodging business is akin to a melting ice cube, and the speed at which it dissolves will depend on how aggressive European governments -- whose rhetoric in clamping down on tax deadbeats has exceeded real action -- will be. No other government has been as aggressive as the U.S. has in putting up demands that the Swiss hand over names of suspected tax dodgers.
But there are signs of pressure. This past week, Italian tax authorities raided local offices of Swiss banks, in what Swiss bankers regard as an attempt to scare tax dodgers. And new treaties Switzerland has signed with France and the U.K. make it easier for those countries to pursue information on suspected tax dodgers.
The tax crackdown isn't the only factor driving European money away. Many European baby boomers are also anxious to bring money home to recapitalize sagging businesses or pass the money on to their children.
For Swiss banks, a fat business is slipping away. Citizens in Italy, Germany and France -- the big three tax-dodging nations -- stashed their money in Switzerland because of political unrest at home, high inflation and sky-high tax rates. They weren't always after high returns, and they complained little about performance and rarely visited their bankers, who typically had them sign discretionary mandates allowing the bank to act on their behalf. Higher fees on discretionary mandates mean such clients are twice as profitable as those who directly manage their accounts. Some bankers privately admit that the fees on undeclared money can be several times those on declared money.
Since around 2000, the bigger Swiss banks such as Credit Suisse Group, UBS, Julius Baer Group AG and Pictet & Cie have tried to diversify away from tax dodgers by opening branches in Italy, Germany and France and building big onshore businesses with these clients. They are also targeting new millionaires in Russia, the Middle East and Asia. With taxes low at home, investors in these countries are instead fleeing political instability. Indeed, Singapore, also courting these emerging-market millionaires, is now Switzerland's main offshore rival.
But the switch isn't painless. A recent presentation by Credit Suisse gave a rare peek into just how rich the undeclared business was. The bank expanded aggressively abroad over the past decade; between 2006 and the first half of this year, just 4% of its net new money came from Western European clients bringing their money into Switzerland; 59% flowed into its booking centers outside the country.
"Bank secrecy in itself cannot be a value proposition," said Walter Berchtold, head of private banking at Credit Suisse, at a presentation recently. "It is important to clients, but the tax angle of it cannot be the driver."
Dirk Hoffmann-Becking, an analyst at Sanford Bernstein reckons that Credit Suisse's operating profit margin on its business managing noncompliant money in Switzerland is 75% -- double the margin on its onshore business. The tax-avoidance business could account for 12% to 15% of the operating profit of Credit Suisse's private bank, according to Mr. Hoffmann-Becking. As that business melts away, Credit Suisse could have trouble hitting its target of 40% operating margin on the private bank, he says.
A spokesman for Credit Suisse said that the bank contests Mr. Hoffmann-Becking's analysis, saying Mr. Hoffmann-Becking incorrectly interpreted figures from a recent presentation to analysts. Mr. Hoffmann-Becking stands by his report.
The low valuations for a raft of recent private-banking acquisitions also show the poor prospects for undeclared money. In October, Julius Baer paid just 2.3% of managed assets for the Swiss portfolio of ING Group NV -- far off the 5% paid just a few years ago -- in part because the book contains a large chunk of European clients.
According to analysts, the biggest losers will be the smaller banks, which don't have the resources to bulk up in the areas tax-compliant clients need. They will also struggle to open overseas offices to lure the new rich of the emerging markets.
