BERN, Nov 24 (Reuters) - Negative interest rates are vital in the Swiss National Bank's efforts to rein in the Swiss franc, SNB Vice Chairman Fritz Zurbruegg said on Thursday, with the associated risks from low interest rates "manageable" for the country's financial system.
For nearly two years the central bank has been charging 0.75 percent on deposits it holds for commercial banks beyond a certain threshold, a step which has come under fire from banks which see it as an additional charge on their activities.
The low interest rate environment has also reduced the profitability from banks' business of granting loans and financing them with deposits.
"Exceptionally low interest rates are putting pressure on interest rate margins and this is weighing on the profitability of Swiss banks," Zurbruegg said in remarks prepared for a conference in Bern.
This was particularly true of domestic-focused banks, such as the country's 24 cantonal banks, whose operations are heavily geared towards interest business, he said.
Negative interest rates had not caused a further erosion of banks' profitability because exemption thresholds granted by the SNB meant most domestic banks have not been hit by the charge, he said.
Banks have also taken on riskier loans to compensate for lower margins elsewhere, Zurbruegg said.
"Looking to the future, ongoing low interest rates are likely to continue weighing on banks' profitability; this, in turn, will create an incentive for them to take on more risk," he said.
But measures like the countercyclical capital buffer - which requires banks to hold capital beyond minimum requirements - has increased the resilience of the sector, he said.
"Thanks to measures taken to date and the capital surpluses that banks have in place, these risks are currently manageable for the financial system."
Negative rates had helped the banking sector by maintaining price stability and supporting the Swiss economy by easing upward pressure on the franc, he said.
"The negative interest rate charged on banks' sight deposits at the SNB is indispensable from a monetary policy perspective," Zurbruegg said.
"Given low interest rates around the world and the difficult global economic situation, negative interest - coupled with the SNB's willingness to intervene in the foreign exchange market - serves to ease upward pressure on the Swiss franc."
Still, with interest rates likely to remain low for the foreseeable future, "all players should remain especially cautious and alert", he said.
"It is thus all the more important that banks put aside sufficient capital surpluses and adopt a conservative mindset when assessing the creditworthiness of borrowers." (Editing by Michael Shields)