Until recently crowdfunding activities in Switzerland were severely restricted by banking regulations. An exuberant legal bank monopoly for the deposit taking business limited both the possibilities for project initiators to procure debt capital and the business models of crowdfunding platforms. Without a banking license, project initiators were only allowed to accept debt capital from at most 20 public investors, and crowdfunding platforms had to transfer the funds they accepted from backers within a grace period of seven days to the project initiators.
The Swiss Federal Council had well recognized these impediments, which derived from the banking regulation. In order to alleviate them, it recently enacted a new Banking Ordinance that came into force on August 1, 2017. The grace period for crowdfunding platforms is now 60 days, if no interest is paid, and project imitators are under certain conditions allowed to accept debt capital from more than 20 public backers. More precisely, the new provisions stipulate that accepting public deposits from more than 20 lenders or publicly recommending oneself for such activities does not qualify as ‘acting on a commercial basis’ and therefore does not fall within the ambit of the banking regulations, provided that (i) no more than CHF 1 million (approximately EUR 878.000) of such public deposits are accepted, (ii) no interest is paid and the deposits are not invested, and (iii) prior to lodging their money, investors are informed in writing that the project initiator is not supervised by the Swiss Financial Market Supervisory Authority and that the deposits are not subject to the deposit insurance scheme. Interest may only be paid by project initiators that primarily run an industrial or commercial business and that use the accepted deposits to finance such industrial or commercial activities. Should the maximum amount of CHF 1 million be exceeded, borrowers are required to notify the Swiss Financial Market Supervisory Authority within 10 days and to file an application for a license under the Banking Act within 30 days.
The new Banking Ordinance certainly improves the legal environment for crowdfunding activities in Switzerland. However, these new regulations mitigate only the money taking and transferring problems caused by the banking regulations; they do not address the fundamental structural aspects of crowdfunding. The most important elements in this latter regard are information asymmetries and collective action problems. From an ex ante perspective, ‘the crowd’ faces substantial information asymmetries concerning the entrepreneur and their projects. In light of the typically small amounts that are invested by each single backer, the costs for reducing these information asymmetries on an individual basis are likely too high for backers and project initiators. Crowdfunding platforms may help to mitigate this ex ante issue by acting as intermediaries that force project initiators to disclose information and to ensure a certain quality standard, which ultimately results in the reduction of transaction costs. It is, however, questionable whether market forces alone can lead to optimal disclosure levels and quality standards.
Information asymmetries also persist after the investment has taken place. At that point, collective action problems prevent backers from solving these ex post problems. Individual investors can hardly monitor whether their funds are used as intended, as they lack the necessary information and they may anyway be rationally apathetic, especially if they hold diversified investment portfolios. In addition to this, usually no exit strategies exist for investors in the form of an organized and liquid secondary market. Crowdfunding platforms could potentially mitigate such ex post issues by representing the class of investors in the exercise of control rights and by facilitating a liquid secondary market. However, in most cases this is legally not possible without falling within the ambit of other financial market regulations and triggering further license requirements, eg for collective investment schemes or market places. On the other hand, it is questionable to what extent market forces alone could lead to efficient structures, if no such regulatory impediments existed. In view of these structural issues, rational actors will either abstain from participating in crowdfunding at all, or they will demand substantial risk premiums. Both of these seem suboptimal for the further development of crowdfunding. Without adequate regulatory intervention, then, crowdfunding will most probably be unable to unfold its full potential. These fundamental issues have, however, not been considered in the legislative debate in Switzerland so far.
The more fundamental question is whether and to what extent the banking monopoly is necessary to achieve the protective goals of the banking regulation. This question does not appear to have been thoroughly analyzed to date. As regards investor protection, the bank monopoly has no apparent function. It does not prevent anyone from granting loans to questionable borrowers or from making bad investment decisions. And providing a rather safe option for retail investors to deposit funds, that is on a bank account, does not require the monopolization of the deposit taking business. Strictly speaking, the bank monopoly only restricts individuals and enterprises in their capacity to procure debt capital and might therefore have some relevance in terms of protecting the financial system. Indeed, by restricting the number or the total amount of public deposits that may be procured without a banking license, the impact of a project initiator’s bankruptcy can be limited. However, it is puzzling why such restrictions, if indeed necessary, should only apply with regard to debt capital and not also with regard to equity capital.
Perhaps the most plausible explanation is that banking monopoly serves other purposes, and in particular it subsidizes banks. But how can this be justified? Implementing and maintaining such a banking monopoly could be necessary in order to facilitate an efficient banking system, with such a monopoly creating positive externalities for the whole economy that outweigh its negative impacts. As banks reduce information asymmetries and transform maturities and lot sizes, obtaining bank credit could on balance be cheaper than procuring funds directly from the public. Hence, efficiency reasons might justify the monopolization of the deposit-taking business. However, do the underlying assumptions hold in economies with overall well-developed capital markets, and are banks in the Internet age still as necessary to reduce information asymmetries and to transform maturities and lot sizes as they used to be? Is the existence of crowdfunding not evidence to the contrary? Any attempt to answer these questions is beyond the scope of this blog post. But the concept of protecting and de facto subsidizing banks by establishing a legal monopoly for the acceptance of deposits on a commercial basis should be fully reconsidered in future research and legislative debate.
The author would like to thank Casimiro Antonio Nigro for his valuable comments. An extended version of this post is also available here.
Tizian Troxler is Dr. iur., LL.M. (Harvard), CAS UZH in Banking, Capital Markets and Insurance Law, Swiss attorney at law, postdoctoral researcher and lecturer at the Faculty of Law of the University of Basel.