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| Hans Lindblad, director general of the Swedish National Debt Office |
Forget gold plating. Armour plating might be a better way to describe Sweden’s rules on bank capital and liquidity.
Spooked about rising household debt, the Swedish regulator hiked the floor on banks’ mortgage risk weights from 15% to 25% in May. The result is that Sweden’s systemically important banks now have minimum regulatory capital requirements ranging from 14.5% to over 19%. By some calculations, that makes Swedbank – which has a 25% share of Sweden’s mortgage market – the most strongly capitalized bank in Europe. Handelsbanken is not far behind.
There’s no guarantee that Swedish regulatory capital requirements have yet reached their maximum altitude. The Riksbank reportedly argued last year that the floor on mortgage-risk weights should have been hiked to 35%. Sweden’s financial services authority countered that there are other tools that could and should be used to deal with elevated household debt before risk weightings need to be revisited.
“Taking into account the risks that real estate can pose to the banks, as well as the risks that banks can create for the real economy, we think that 25% is an appropriate floor,” says Uldis Cerps, executive director for banking at Sweden’s FSA. “If we detect a need to dampen loan demand, we have other macro-prudential tools at our disposal such as amortization requirements, lower loan-to-value rules, or the introduction of maximum loan-to-income ratios.”
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Swedish banks’ business models are characterized by a very high reliance on market funding compared with their European peers Uldis Cerps |
Don’t bet your mortgage against a further rise, however. This is because there are plenty of reasons why the Riksbank, in particular, continues to be twitchy about Sweden’s banking system, just as regulators across Europe have been for a while.
“You didn’t need to be Einstein to recognize that capital requirements needed to be increased after the crisis throughout Europe,” says Jan Erik Back, chief financial officer at SEB in Stockholm.
Although the CEOs of some Swedish banks have used the press to fire off angry broadsides about high capital requirements, Back says that the industry has been broadly supportive of the tougher stance the authorities have taken. Indeed, he adds that the banks themselves initially moved to bolster their capital levels before regulation obliged them to do so.
At Swedbank, group chief financial officer Göran Bronner makes a similar observation. “In 2008 and 2009 we welcomed the regulator’s tougher stance on capital because we thought risk-weighting floors of 5% on mortgages were ridiculously low,” he says.
Bondholders, too, clearly like what they have seen from the Swedish regulator. “Sweden is the first country in Europe to have articulated and disclosed very clear and detailed capital requirements for individual banks,” says Khalid Krim, head of capital solutions, EMEA, at Morgan Stanley in London. “This may be seen as being painful for Swedish banks, bringing total capital requirements to about 20%, compared with the 17% to 20% that is required by other European regulators. But we think it will confirm the perception among investors that Swedish banks are top of the league in terms of capital ratios. This is already reflected in their senior unsecured and CDS spreads, which are among the tightest in the European banking sector.”
Idiosyncrasies
While the Swedish banking sector has shared many of the challenges of the wider global industry since the crisis, it has several idiosyncrasies that make it more vulnerable than many of its competitors. One of these is its size. At four times GDP, this might be modest compared to pre-crisis Iceland, which had a banking industry 12 times the size of its economy, according to Alexander Ekbom, credit analyst at Standard & Poor’s in Stockholm. But it is big enough to unsettle the regulators. So too is the hunger of Swedish banks for the wholesale funding they need to sustain such a large system, which is reflected in an uncomfortably high loan-to-deposit ratio approaching 200%.
“Swedish banks’ business models are characterized by a very high reliance on market funding compared with their European peers,” says Cerps at the FSA. “This means banks do not only need to be financially strong. They also need to be perceived to be financially strong.”
If that risks compromising the competitiveness of Swedish banks, so be it. “The efficiency of Swedish banks is such that they are well-equipped to absorb higher minimum regulatory capital requirements,” says Jens Hallen, analyst at Fitch Ratings in London. “But if there is a choice to be made between financial stability and banks’ competitiveness, financial stability is clearly prevailing.”
It’s not just the size of the Swedish banking industry that makes the authorities edgy. The concentration in the system and the interdependence of the four leading banks is another vulnerability, given their reliance on covered bonds, a potentially unhealthy proportion of which are absorbed by domestic banks.
The Riksbank says that banks’ cross-holdings of other securities, chiefly covered bonds, amount to an average of 40% of their equity. “These tight interconnections mean that problems in one bank can rapidly impact confidence in the entire banking sector and consequently also in large parts of the financial system,” warns the fretful central bank.
Economists say the main cause of the authorities’ debt-angst, however, is their memory of the turmoil of the 1990s. Then, there were a number of drivers of Sweden’s banking crisis, one of which was a debt level that reached 130% of disposable income, according to S&P. That puts an alarming perspective on today’s figure of over 170%.
It also explains why the Riksbank is having kittens about Sweden’s mortgage mountain, with representatives from the central bank reportedly more convulsed with fear about household debt than their fellow policymakers on the financial stability council. This is a forum in which representatives of the Swedish FSA, the national debt office and the Riksbank regularly convene to exchange ideas on how “financial imbalances can be counteracted.”
Market evolution
There are a number of explanations for elevated debt levels in Sweden which, say market participants, are probably not as worrisome as the bald numbers might suggest. Hans Lindblad has watched the evolution of the Swedish housing market from the vantage point of the ministry of finance, the Riksbank and most recently Sweden’s National Debt Office, where he has been director general since February 2013.
He says he is not as troubled by the debt mountain as some policymakers for several reasons. One of these is Sweden’s high savings ratio, reflected in the current account surplus. Another is the fact that more than 90% of the increase in household debt can be attributed to sound fundamentals. Lindblad says it is the rise in home-ownership, the abolition of residential taxes on houses and falling interest rates that have been the impetus for rising household debt, rather than speculation or a buy-to-let binge.
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| We’re under no pressure to raise AT1, but it would be beneficial to be given some clarity about the trigger levels Jan Erik Back |
Others share the view that financial stability in Sweden is not necessarily menaced by high debt and inflated property values. S&P’s Ekbom reckons Swedish houses are overvalued by about 25%. “That does not mean there would be a catastrophe in the banking system if the housing market loses steam,” he says. “Look at Denmark, where banks’ losses were minimal even after a 30% fall in house prices.”
The bigger worry, adds Ekbom, is that a fall in house prices would engender a collapse in consumer confidence, with obvious implications for the corporate sector in general and for domestically oriented SMEs in particular. “This is a legitimate concern, because we have reached a point where Swedes are leveraged more highly than ever, with some first-time buyers indebted by six to seven times income,” he says. “But we think incomes are growing faster than debt, which will create equilibrium over time.”
Besides, say a number of economists, the Sweden of 2014 is very different from the Sweden of the early 1990s. “As well as a speculation-driven property bubble, there were serious imbalances in the economy leading up to the crisis,” says SEB’s chief economist, Robert Bergqvist. “We ran sizeable current account deficits throughout the 1970s and 1980s and had large and rising levels of government debt, all of which has since been reversed.”
Debt challenge
None of this is to suggest that the debt challenge is something that the largest Swedish banks are belittling or ignoring. At SEB, for example, Back says that his bank was the first to require its customers to amortize their mortgage debt down to below 70% of loan-to-value.
More recently, the CEO of the Swedish Bankers’ Association has publicly urged all banks to reduce their amortization thresholds from 75% to 70%, and it’s easy to see why. The FSA has reportedly calculated that if they don’t speed up their mortgage repayments, it will take Swedes an average of 140 years to pay down their home loans. According to the IMF, almost 40% of mortgage borrowers in Sweden didn’t reduce their debt at all in 2013.
The general consensus among bankers and analysts is that measures such as mandatory amortization and eliminating tax deductibility on mortgages would help to address the problem of Sweden’s elevated household debt levels. In the run-up to this year’s general election, neither of these options has been explored by politicians. For obvious reasons, they have been happier to leave the banks to address the threat of an overheated property market by passing on higher charges to borrowers, the efficiency of which is questioned by bankers.
“All the stress tests show that Swedbank would be less affected by a real-estate crash than any of the other banks because we have the lowest exposure to corporates, but we have the highest capital buffer. Where’s the logic in that?” asks Swedbank’s Bronner. “The only logical answer is that it is a mechanism for maximizing the steering effect through higher mortgage rates. Over time, that may create problems by steering credit away from mortgages and towards corporates, where margins are higher and risk weights are lower.”
Bronner echoes a number of others when he says that it is a mistake to place all the focus on the demand side of Sweden’s housing market conundrum. “I’m not sure that capital is the right way to deal with the underlying problem,” he says. “The underlying issue is that the Swedish population is growing very rapidly due mainly to immigration.”
That, says Bronner, is positive for the economy. But it is also aggravating an acute housing shortage, especially in the Greater Stockholm area, which is a legacy of the crisis of the 1990s. “The supply situation changed significantly following the crisis, after which the public sector pulled out of the housing market,” he says. “Addressing the housing shortage is a multi-faceted political challenge, with complications arising from environmental laws and municipalities’ rights. But I think that most people recognize that the only way out of this dilemma over the long term is to build a lot more housing. This will only happen if banks are encouraged to lend, so drowning them in capital is not the best long-term solution.”
| This is the wrong time to introduce a counter-cyclical buffer, given that a number of indicators are pointing towards a shortage of demand and falling underlying inflation Hans Lindblad |
Maybe not. But today, say Stockholm bankers, lofty capital requirements are having no negative impact on Sweden’s top banks. If anything, their net impact is positive, because they are helping to ensure that the funding costs commanded by Sweden’s banks in the international capital market remain among the most competitive in the world.
“Today, all the big Swedish banks have strong balance sheets with good access to funding markets in pretty much any geography, currency and term that they want,” says Back at SEB.
The funding advantage enjoyed by Sweden’s banks in the international capital market will be supported by their regulator’s approach to crisis resolution and, more specifically, to bail-in. For very obvious reasons, the notion that senior unsecured bondholders are at risk of losing their shirt in the event of a bank collapse is poison to a system as dependent on wholesale funding as Sweden’s. The consequence is that Sweden is insisting on adopting a flexible approach to the implementation of the Bank Recovery and Resolution Directive (BRRD).
That, according to a recent update from Danske Bank, will mean opting for precautionary capitalization rather than bail-in of senior unsecured bondholders. “For investors fearing the bail-in of senior debt this is good news, at least for the four largest Swedish banks, as this will effectively leave senior creditors out of the equation and with some probability also subordinated debt,” says the Danske research.
Threat to the benign
Even in the short term, however, some fear that well-intentioned but over-zealous regulation might pose a threat to the very benign operating environment that Sweden’s banking system and its economy enjoy today.
At the DMO, Lindblad is especially uneasy about the proposed counter-cyclical buffer that will add another layer of capital to the Swedish banks’ overall regulatory requirement.
The good news, for the banks, is that it looks unlikely that this will be set at the 2.5% level that the IMF, for one, has called for. The bad news is that in spite of diverging opinions on the buffer within the financial stability council, it is probable that the banks will be required to hold an additional 1% of core tier-1 capital as from the summer of 2015.
Lindblad has made no secret of his misgivings about the counter-cyclical buffer. “I agree that it is prudent for Sweden to have high capital requirements,” he says. “But I think this is the wrong time to introduce a counter-cyclical buffer, given that a number of indicators are pointing towards a shortage of demand and falling underlying inflation in the Swedish economy.”
Lindblad reckons that for every 1% that is added to banks’ capital requirements, Sweden’s GDP is reduced by 0.1% or 0.2%. At a time of such uncertainty about the outlook for growth in Europe, Lindblad says that Sweden needs to pause for breath before putting another layer of capital demands on to the shoulders of the banks. “If our capital requirement is 16% when the minimum is 8%, we could be reducing potential GDP by as much as 2%, which would be very costly for society and public finances,” he says. “So I think that before we go any further in terms of capital, it’s important that we call for a short halt to evaluate the impact on the banking and household sectors.”
Over the longer term, some Swedish bankers say there are other good reasons for them to be unsettled by the toughness of their regulators’ stance on capital. “In the short to medium term, everything is fine for the Swedish banks,” says SEB’s Back. “The question is: how will things pan out over the much longer term? Ten years from now, is it going to be possible for Swedish banks to compete with capital ratios that might be between 15% and 20% when the rest of the world is running with 10%? The Swedish politicians argue that the rest of the world will eventually apply the same ratios as Sweden, but I’m not sure we can take that for granted.”
| Further reading |
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Financial regulation: special focus |
Back adds: “International banks are starting to return to the Swedish market, albeit very gradually. In five, 10 or 15 years’ time they may pose a real competitive threat to the Swedish banks.”
Swedbank’s Bronner agrees. “When there is a sustained pick-up in growth, we may see more large banks coming into this market,” he says. “That is some way off, because as long as there is uncertainty over bank resolution in Europe, I don’t see banks focusing on cross-border opportunities.”
No wonder the prevailing view across Scandinavia is that a move towards harmonization of capital requirements would be helpful both for the region’s banks and for investors comparing regulatory regimes.
“The idea behind CRD IV was to have a single rule-book for Europe, but what has emerged has been the opposite,” says Johan Hansing, chief economist at the Association of Swedish Banks. “Even within the Nordic region we are a very long way from having a single rule-book on capital requirements, which we think may be damaging for Swedish banks’ competitiveness.”
Common ground
Before the regulators across Scandinavia can reach an agreement on a Nordic finish, policymakers in Sweden need to find some common ground on formulating and implementing a more coherent Swedish finish. Take the lack of clarity and decisiveness on the conditions under which Swedish banks would access the market for additional tier-1 capital, which they will need to do if they are to conform to CRD IV’s requirement to hold 1.5% of their risk-weighted assets in AT1.
Banks say they are ready and willing to issue in the AT1 market, but will be unable to do so as long as there is uncertainty about the level at which write-down or conversion would be triggered for Swedish borrowers.
CRD IV sets the minimum loss absorption trigger at a CET1 ratio of 5.125%, which many European regulators plainly regard as laughably low. It is especially inappropriate for a highly concentrated banking system such as Sweden’s, given that long before any of the banks’ CET1 were to fall anywhere close to 5.125%, sky-rocketing spreads across the entire system would effectively price all of them out of the market.
While Sweden has therefore understandably ruled out a loss absorption trigger of 5.125%, it appears to be uncertain about what level would be most appropriate given the size and structure of its banking system. Some rumours have suggested that the über-conservative regulator has considered a trigger of 9%, which would be well above the 7% level favoured by most European regulators. It would also be out of synch with the only Nordic AT1 issue to date, Danske’s €750 million transaction in March, which will be subject to write-down if the issuer’s CET1 falls to 7%.
Stockholm-based bankers believe that a 9% trigger is highly unlikely, although they don’t rule out a level of about 8%, which would be in line with the regulator’s conservatism. They are also confident that the same trigger will apply for all Swedish banks, even though each bank is subject to a different CET1 ratio. Irrespective of what the trigger turns out to be, bankers say that it is essential that the regulator makes and communicates a decision sooner rather than later.
“For a while, we’ve been saying to the regulator that the loss-absorbing trigger for AT1 should be part of the Swedish finish,” says SEB’s Back. “We’re under no pressure to raise AT1, but it would be beneficial to be given some clarity about the trigger levels so that we can take advantage of the window of opportunity that is now open to issue at fantastic spreads.”
Investment bankers would no doubt sympathise. When KBC of Belgium came to the AT1 market in March with a €1.4 billion transaction, its pricing of 5.625% was regarded as a new pricing floor for European AT1. It was certainly a very far cry from the 9% coupon offered by Spain’s BBVA when it opened the market for CRD IV-compliant AT1 for European banks in May 2013.
“Since the KBC deal there has been a debate about whether we could see a European AT1 transaction priced below 5.625%, possibly even with a 4% handle,” says Krim at Morgan Stanley, which was one of the five bookrunners on the KBC deal. “The general view is that the best candidates for achieving tighter pricing levels are the Swedish and Dutch banks.”
That might be. But not until the finishing touches have been made to the Swedish finish.
