An upcoming referendum in Switzerland could fundamentally change the country's monetary system.

The vote will be on the introduction of the sovereign money initiative, which would end fractional reserve banking in Switzerland.

Such a system has not been tried in centuries and there are serious questions about how it would be implemented.

Economists from UBS examined what the implementation of the new system might look like if the vote passes.



In just under a month, voters in Switzerland will be asked to decide whether or not to approve a proposal that could — in theory at least — change the entire face of the global financial system.

On June 10, a referendum will be held asking Swiss citizens if they back the introduction of a concept known as the sovereign money initiative, proposed by a group called the Vollgeld Initiative.

At it's most basic level, the sovereign money initiative boils down to a change to what is recognised as money and would stop banks being able to extend credit in the way the have done for centuries.

First, it's important to understand the difference between sovereign money and book money: sovereign money is money brought into circulation by the central bank of a given country, and according to Vollgeld Initiative campaigners, makes up around 10% of the money in circulation in Switzerland. The other 90% is either electronic or book money and is created by non-central bank institutions such as regular banks through lending.

Banks create this book money by lending out the money they are given in customer deposits and mortgage payments. They are only required to hold a fraction of this money on their books, even though customers still own this money, and lend the difference. This is known as fractional reserve banking but under the new proposals banks would not be able to do this, curtailing their ability to create new money.

Under the proposals put forward by the Vollgeld Initiative, all deposits made to regular banks in Swiss francs would not be placed on their balance sheets, but instead held by Switzerland's central bank.

Early signs are that the vote will be fairly close, with a recent poll showing 45% against the proposal and 42% in favour, meaning there's a real chance of Switzerland actually implementing this monumental change.

But how would it work in practice? In a recent note to clients, economists at UBS led by Felix Huefner took a look at some of the possible implications.

The first, and most obvious, implication is that the Swiss National Bank — which is strongly opposed to the initiative — would be forced to fundamentally alter the way it carries out monetary policy.

"While nowadays the SNB [Swiss National Bank] aims to steer the money supply through setting interest rates, in a sovereign money system it would return to monetary targeting," the team wrote.

Monetary targeting is a form of central bank policy where the central bank sets the interest rates to control monetary aggregates — basically controlling the number of different kinds of money (cash, bank deposits, mortgages etc).

"A possible consequence of such an overhaul is the restriction of credit supply to those sectors of the economy that depend on bank financing, and loans would likely become more expensive," UBS' team said.

Banks would also have to undertake the likely laborious process of actually shifting all the money on their balance sheets over to the Swiss National Bank. That process would take time and likely cost a significant amount of money.

"To smooth the changeover, it is planned that during the implementation phase (when customer deposits are effectively shifted to the SNB), the SNB would grant temporary transition loans to the banks," UBS said.

A further uncertainty that the referendum would likely throw up is how — or even if — the SNB would be able to steer Switzerland's money supply, something also flagged by UBS.

"In the initiative's proposal, sovereign money would not be created through SNB market operations but rather 'debt-free' as a transfer to the government, the cantons or the public," the bank's team adds.

Whether or not Switzerland wants to abandon fractional reserve banking is unclear, but what is clear is that doing so would create lots of issues to deal with. As such an experiment has never been tried before, it seems likely that Swiss authorities would simply have to muddle through in implementing the outcome of the referendum.