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U.S. cranks up the heat on Swiss bankers

The logo of the Swiss bank Wegelin. The U.S. Justice Department indicted the bank, Switzerland's oldest, on Feb. 2, 2012, for allegedly enabling U.S. citizens to evade taxes through secret offshore bank accounts.

Michael Buholzer/Reuters/Michael Buholzer/Reuters

Until recently, the quiet Swiss town of St. Gallen was best known for the medieval manuscripts housed in its abbey library.

But lately the city has had to grapple with a less pious claim to fame: St. Gallen is home to Wegelin, a private bank indicted by U.S. authorities this month for allegedly helping rich Americans evade taxes.

It's no secret that banking is a big business here in St. Gallen, as it is throughout Switzerland, accounting for some 6.7 per cent of the country' gross domestic product in 2010. Banks are scattered throughout the pretty streets of the old town, some world giants like Credit Suisse Group AG and UBS AG and others unknown to the masses. It is here in this unassuming town near the Austrian border that some of the world's wealthiest citizens entrust their fortunes to discrete bankers who guarantee their confidentiality.

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But that secrecy is increasingly under attack by dogged U.S. investigators.

The U.S. Justice Department is investigating 11 Swiss banks or foreign banks' Swiss subsidiaries, including Wegelin, Credit Suisse, Julius Baer, Basler Kantonalbank, HSBC, and Zurcher Kantonalbank (ZKB). The Swiss recently sent 20,000 encrypted banking documents to U.S. authorities, saying it could help decode them when a settlement is reached, according to a report from Bloomberg News.

The Swiss have been taken by surprise at how quickly and devastatingly the U.S. authorities are chipping away at their prized banking secrecy tradition.

Martin Naville, chief executive officer of the Swiss-American Chamber of Commerce said the writing was on the wall and the Swiss knew that tax secrecy wouldn't last forever. But that doesn't mean some are happy to let it go, he said, pointing to the criticism directed at one Swiss ex-banker who wrote a book saying that banking secrecy spares the Swiss from competition, making them "fat, but impotent."

"A lot of people thought banking secrecy would go away over 10 years, but it has obviously not happened that way," said Mr. Naville in an interview at the chamber of commerce's Zurich office.

In the case of Wegelin, which traces its roots back to 1741, the shock was that the U.S. would come after a small Swiss private bank with no branches in the U.S. Some fear other Swiss banks may also disappear amid the tax crackdown.

"This is the first time an overseas bank has been charged by the United States for facilitating tax fraud by U.S. taxpayers," the U.S. Department of Justice said in statement announcing the charges against Wegelin.

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In St. Gallen's heart stands a baroque building where Wegelin, Switzerland's oldest private bank, used to do business. But the imminent threat of U.S. charges forced its owners to sell to rival Raiffeisen at the end of January. Wegelin's ensuing indictment on Feb. 2 rattled the Swiss, who believed they were making progress in their negotiations with the Americans over their long-running tax dispute.

"People in Switzerland consider this as an attack on Swiss banking," said Martin Brown, a professor for banking at the University of St. Gallen.

But Prof. Brown stresses the changes forced upon the Swiss by the tax fight, however painful, are necessary.

"This is going to hurt the Swiss banking industry in the short term, certainly. But it's going to hurt the Swiss banking industry the same way closing down the coal mines in the U.K. in the 1980s hurt the U.K. industry. You're offering financial services that are obsolete."

It's a view that some Swiss don't want to acknowledge. Banking has been good to this small alpine country. Wealth is prominently on display in Zurich, where women bundled in fur coats and private bankers in sleek suits and coats stroll along the streets. The main street, Bahnhofstrasse, is among the world's most exclusive addresses, where the well-heeled go to buy designer clothes and stunning jewellery.

But there's a darker side to Swiss banking, the one depicted in countless Hollywood movies where unsavoury people hold a Swiss bank account because of dodgy business dealings.

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Switzerland gained its reputation as a tax haven over the decades thanks to its strict banking secrecy law that was put in place in 1935. While the Swiss argue that banking secrecy protects the client, critics say the banks are taking other countries' money to enrich themselves. A report last year from Boston Consulting Group said Switzerland is the top market for offshore money, holding some $2.1-trillion (U.S.) in assets.

The loss of tax revenue has been a sore point for many governments. But the U.S. really began to crack down on the Swiss in 2008 when allegations emerged that employees at UBS, Switzerland's biggest bank, helped Americans avoid taxes. UBS admitted its guilt the following year, agreeing to pay a $780-million fine and hand over the names of 4,450 U.S. accounts. In return, prosecution was deferred and UBS could continue to operate in the U.S.

That act changed the course of Swiss banking history forever.

The tax fight, teamed with volatile global financial markets, and new banking rules, are making life difficult for Swiss banks. Swiss daily Tages-Anzeiger, citing experts, recently reported that the number of bankers in Switzerland could fall to 80,000 in coming years from 108,000 last year.

Some Swiss banks are changing the way they operate in the U.S. ZKB, for example, is exiting the business of offering bank accounts to clients who reside in the U.S. When Raiffeisen bought Wegelin, it left behind the U.S. customers.

At ZKB's annual results press conference on Friday, CEO Martin Scholl described the U.S. tax dispute as a challenge but insisted the bank is not scared.

What the Swiss would like to see is a resolution that lets them hold on to the concept of banking secrecy while still dealing with the tax evasion issue. They also want an agreement that covers all Swiss banks rather than just the ones being investigated.

One model is recent tax agreements reached between Switzerland, Britain and Germany, which would see the Swiss impose a withholding tax on assets that would be passed on to those governments without exchanging customer data.

"That's a model that should work quite well," said Sindy Schmiegel Werner, a spokeswoman for the Swiss Bankers Association.

But those deals have come under criticism from the European Commission, and Prof. Brown doubts the U.S. authorities would go for it.

Even if Switzerland loses its fight for banking secrecy, the country has other strengths to draw upon, experts say. The country still offers political and economic stability, important considerations when depositing money.

As well, the Swiss economy isn't just based on banking. The Swiss have created many other world-renowned businesses including drug makers Roche and Novartis and food giant Nestlé.

"Probably it will strengthen Switzerland at the end of the day because we get away from this myth that private banking is the only reason why we're rich," Mr. Naville said.

Special to The Globe and Mail

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