Nordic banks might not be the right model
Efficient and well-capitalized, Scandinavian and Dutch banks are the darlings of Europe’s investor community. But if pride is the worst sin in banking, they could be heading for a fall.
For analysts and investors, even fellow bankers, there seems to be an almost mystical brilliance to the Nordic banking sector.
Sweden’s big four banks have a combined market capitalization that dwarfs that of their peers in Italy, although Italy’s economy is more than three times larger than Sweden’s. The brilliance sometimes even rubs off on Dutch and Belgian lenders. The combined market capitalization of the biggest listed Dutch banks, ABN Amro and ING, is now around twice that of Germany’s Commerzbank and Deutsche Bank.
There is no secret recipe to the Nordic and Benelux banks’ success, it is largely about efficiency – something that might be more readily achieved in a close-knit, oligopolistic banking sector with a focus on retail banking. Of the big listed Nordic banks, only SEB, with its greater corporate focus, had a cost-to-income ratio above 50% in 2016. Running insurance businesses – easing reliance on rate-squeezed interest margins – is another help.
But boosting profit margins by cutting costs is easier than running a bank that is appealing to its customers and staff. It is also much easier than sustaining a lending model that extends the right amount of credit to the right customer, at the right price and the right time. This is the real essence of excellence in banking and it is extremely difficult to get right, even once you strip away the mind-bogglingly complicated regulatory costs of banking today.
Banking’s image problem in part derives from the leverage inherent in these institutions, in which small risks can open big holes in their financial standing. They are inherently unstable, not least because their actions determine the value of their own security. The extent to which Nordic banks are really better than others in Europe would therefore be down to better management of risk, particularly in real estate.
The accepted wisdom today is that Swedish banks are indeed better risk managers because they have embedded the experience of their real estate-derived banking crisis in the early 1990s. Or so the story goes.
The other reason why banks like Svenska Handelsbanken have been so popular with investors of late is that their relatively simple, single-country focus is fashionable. Investors and regulators alike have punished complexity and imposed higher costs on international operations: from sanctions-busting fines, to restrictive capital adequacy and funding requirements on local subsidiaries. Until recently, US-focused Wells Fargo was the quintessential example of the fashionable bank.
However, Nordic banks are specialized to the point of weakness. Wells Fargo might have shunned international ambition, but the US is big enough for any bank. Even Lloyds’ UK-centric strategy allows a more multifaceted business than can be found in Sweden, with its 10 million people huddled around a handful of urban centres. The biggest Nordic bank, Nordea, is really only diversified within Scandinavia. The odd bit of business in the UK, or perhaps in the even smaller Baltic states (themselves closely linked to Scandinavia) is hardly a sufficient balance.
Meanwhile, memories of crisis are fresher elsewhere in Europe. The Nordic housing market is booming, fuelled by ultra-low interest rates. No wonder local governments and regulators are worried, although macro-prudential measures have done little to cool the market so far.
The Nordic banks all have strong capital ratios, and the regulators want them to set aside even more. Handelsbanken and Swedbank’s common equity tier-1 ratios are already more than 20%. But capital ratios can be misleading; they are there to cover losses. Anglo Irish Bank had almost a percentage point more tier-1 capital than BNP Paribas and Santander in 2006. Those 100 basis points might have bought a bit of time but did not prevent collapse when Anglo started racking up billions of euros of losses.
Pride comes before a fall, as the saying goes; and if you are looking for the proudest banks in Europe today – perhaps ones to follow the experience of Wells Fargo over the last year – you could do worse than look north.
In fact, Dutch and Nordic arrogance has had particular relevance of late in the debate over new Basel risk-weighting standards. The Dutch and Nordic banks have far lower average risk weightings than southern European lenders like BBVA and Santander. That should indicate lower risk in these markets – and perhaps it does, to some extent. But how much? If high risk weightings are a sign of greater dangers, then higher capital ratios may be too.
Italians have an unusual tendency to talk down their country. This is either healthy scepticism or self-fulfilling, depending on how you look at it. The Dutch and the Swedes could have the opposite problem. Their bankers’ confidence might also be self-fulfilling, but confidence is all in the mind. Bankers in any country have nothing to fear but their lack of fear.