Sweden's banks are often the envy of Europe, with their strong growth and impressive capital ratios. Heavily guarded against complacency, the Riksbank warns of some vulnerability to volatility. Peter McGill assesses if these concerns are valid.
Swedish banking draws sharply divergent views.
The banks themselves are understandably proud of their achievements, which to foreign admirers resemble the Promised Land. “Swedish banks have the best capital ratios in Europe, and the lowest cost-to-income ratios, as well as the best historical growth records,” says Ronit Ghose, Citi’s global head of banks research.
No room for complacency
Yet this prosperous Nordic powerhouse, many of whose 10 million people are highly skilled and trained, is the same country whose banking system exploded in the early 1990s in a spectacular property crash. Sweden’s central bank, which takes its role as a guardian of financial stability very seriously, is noticeably absent from the cheering chorus. Where credit ratings agencies celebrate strengths – Swedish banks are among the highest rated by Standard & Poor’s and Fitch – the Riksbank instead points to weaknesses and cautions against hubristic complacency. In a February 5 address to the Riksdag, the Swedish parliament, central bank governor Stefan Ingves drew attention to a rising level of household indebtedness and a large, concentrated and interconnected banking system, increasingly exposed to property and dependent on foreign funding.
Ultimately, both the main contributor to Swedish bank profits and chief cause of concern for both the Riksbank and Sweden’s financial supervisory authority (FSA), the Finansinspektionen, is the property market.
Adjusted for inflation, nationwide prices of tenant-owned apartments have more than quadrupled since the mid-1990s and in Stockholm they have risen almost sevenfold. Real prices of single-family houses have more than trebled. While house prices began to fall off in late 2017 and have since stabilised – largely as a result of additional supply and new amortisation requirements – Swedish household debt, of which mortgages comprise more than 90%, has continued to grow faster than income and now stands at more than 185%. One-third of households with mortgages have a debt-to-income ratio in excess of 400%, and for 13% of mortgage borrowers the ratio is more than 600%. Understandably, the Riksbank considers high household indebtedness to be the biggest risk to Sweden’s financial and economic stability.
Mortgage worries
Some of the causes of Sweden’s dysfunctional housing market are linked to taxation and are amenable to reform, but other factors too are at play.
“The policy of negative rates has fuelled the growth in house prices and mortgage prices, but it’s not the only problem,” says Mr Ghose. “Swedish house price growth is very much a Stockholm phenomenon. All the jobs are being created in Stockholm, so all the young people want to live there, but not enough houses and apartments have been built. On top of the supply bottleneck, interest rates make it so cheap to borrow, stoking demand.”
In December, the Riksbank raised its main policy rate for the first time since 2011, to -0.25% from -0.5%. With about 70% of Swedish residential mortgages on variable interest rates, further increases are deeply sensitive given the pivotal importance of mortgages to household saving and spending, the banking industry and the wider economy.
“High household debt is a central concern for the Riksbank in terms of how it approaches its plans to increase interest rates. Keeping rates too low may encourage further indebtedness, while raising too quickly could choke consumption and activity,” says Neal Kilbane of Oxford Economics.
Bank exposure to property is substantial. Residential lending by all banks and mortgage institutions almost tripled between 2004 and 2018, to SKr4191bn ($458bn), equivalent to more than 90% of Sweden’s gross domestic product.
As of September 2018, mortgages made up 57% of total loans by the four major banks – Swedbank, Svenska Handelsbanken, SEB and Nordea – and 73% of their total lending to Swedish corporates and households had residential property as collateral. Another 8% was being lent against commercial property.
Until the mid-1990s, mortgage lending was detached from general banking, but the four biggest banking groups now account for about 80% of mortgages in Sweden.
The success stories
None of this is to deny that Swedish banking has many enviable attributes.
Return on equity for the major Swedish banks has been higher than the average for major banks in the EU since 2010. A favourable economy has contributed to low credit losses. The share of non-performing loans in Sweden’s banking sector, 1%, is well below the 3.6% average for EU banks. Net interest income of banks has continued to increase thanks to increased lending and stable interest margins. When combined with lower outlays than most of their European peers, this gives Swedish banks a startling efficiency.
“If you go back to the mid-1990s, only Svenska Handelsbanken was in the 40% range for cost-to-income efficiency. It was considered to be in a league of its own. The rest of the pack, such as Nordea or SEB, were in the 50% or 60% ranges. Over the next 20 years, cost-to-income ratios improved, and all the other banks tried to replicate the Handelsbanken model in retail banking. Swedbank, for instance, has tried to copy the more decentralised, local autonomy-driven business model,” says Mr Ghose of Citi.
Another often overlooked cost-income benefit of Swedish banks is that they “don’t pay their senior staff millions and millions of krona or dollars or euros,” he adds.
Consolidation wave
A wave of consolidation that followed the bursting of the property bubble in 1991-92 certainly helped. The government bailed out large swathes of a near-insolvent banking system. Among the banks, only Handelsbanken did not seek state support. Myriad farm co-operatives and savings banks were restructured, with Swedbank in today’s form emerging out of the maelstrom. Many failed or failing banks were merged with an urban working-class bank called Nordbanken, now the Swedish pillar of Finland-based Nordea, the largest bank in the Nordic region.
Forced on it by crisis and government intervention, the restructuring of Sweden’s banking industry yielded significant cost advantages.
“Mergers helped because they reduced the number of players and made Sweden more oligopolistic. Market structure is always a big driver of returns and efficiency. All things being equal, if you’ve got fewer players, it helps,” says Mr Ghose.
This view is naturally disputed by the Swedish Bankers’ Association. Stung by criticism of rising prices for consumers and bigger bank profits, the association commissioned a 64-page report that argues there is no lack of competition in the Swedish banking market and that higher mortgage margins are driven by mainly due to increasing capital requirements (Competition in the Swedish Banking Sector, June 2018).
Olivia Perney, Fitch Ratings senior director for banks in Europe, the Middle East and Africa, agrees that concentration has helped Swedish banks. “When we look at highly rated banks in the world, they are usually in concentrated banking sectors. Concentration usually helps the banks to make money,” she says.
A digital embrace
Swedish banks are highly automated and digitised, and have leaner branch networks than their counterparts in most other European countries. Cheque payments were phased out in 2010 and electronic payments have become so common that Sweden appears to be heading towards a cashless economy. The Riksbank has responded with a proposal for its own digital currency, or ‘e-krona’.
Mr Ghose believes the quick and ready embrace of digital banking has cultural roots. “Swedes have been early and pragmatic adapters of technology. It’s not that they have better technology or more PhD geeks in artificial intelligence than banks in the Far East or the US, but that they have applied technology in a very sensible way. Part of it is the Swedish DIY culture. It’s no surprise that Ikea comes out of Sweden. Nordic countries have a very strong streak of self-reliance that makes it easier for banks to make their clients do more of the work.”
A share preference
So much for the impressive superstructure. Besides reliance on the property market, it is the funding foundation that most worries the Riksbank.
Banks in Sweden and Denmark have a large deposit deficit because Swedish households prefer to invest in shares, funds and pension products instead of savings accounts. “They are forced to put a lot aside for pensions. There is also a real culture in Sweden of investing in financial products, especially equity,” says Ms Perney of Fitch.
Swedish and Danish asset managers and insurance companies recycle these funds into the local banks by investing in covered bonds, creating deep and captive local markets, which in turn is the main source of funding for mortgage lending.
‘Swedish households invest in Swedish krona so these pension and insurance companies have a lot of krona they need to invest, and the best product for them is Swedish covered bonds. In Sweden, you have a currency effect which creates a captive investor base,” says Ms Perney.
Covered bonds account for 22% of the liabilities of the three largest banks based in Sweden – Svenska Handelsbanken, Swedbank and SEB – and unsecured securities another 25%, according to the FSA. Deposits from the public make up only 25%, and deposits from ‘others’ 28%.
This leads to a major mismatch in maturities, the Riksbank points out. On the asset side of their balance sheet, the major banks have a large proportion of mortgages with long maturities; according to the FSA, the majority of mortgages issued have a maturity of 30 to 50 years. On the liabilities side, they have relatively short-term wholesale funding. The remaining average maturity for Swedish covered bonds is between two-and-a-half and four years, depending on the currency.
Funding currencies
Besides this long-term, structural liquidity risk, there are also short-term liquidity risks from funding in foreign currencies. More than half of the three major Swedish-based banks’ total funding is in Swedish krona, with the rest in foreign currencies. Slightly more than half of their deposits are made in krona, while most market funding is in foreign currency.
Fitch does not regard these liquidity risks in such a harsh light as the Riksbank. “We rate these banks fairly highly despite the fact that they are wholesale funded because they are extremely professional in the way they manage wholesale funding,” says Ms Perney. ‘They are very good at liquidity management, at managing the various maturities. That’s a must.”
Banks that were heavily dependent on market funding were among the most exposed to the global financial crisis. The capital defences that Swedish banks erected in its wake, on the orders of the FSA, certainly appear imposing. The major banks’ average capital in relation to risk-weighted assets (core Tier 1 capital ratio or CET1) stood at 21.4% in late 2018, well above the EU average. However, the Riksbank points out that their CET1 capital of about SKr600bn is below the four major banks’ total lending to financing of housing construction, of about SKr750bn.
The Bank for International Settlements recommends that banks adopt another safety measure, the leverage ratio, as a “backstop” to risk-weighted capital ratios. The leverage ratio includes off-balance-sheet exposures. It is defined as a bank's Tier 1 capital divided by both its on- and off-balance-sheet exposures, including derivatives and securities financing transactions.
When the leverage ratio is applied to major Swedish banks, they fall well behind other countries in Europe. The Riksbank has proposed that the FSA set a minimum leverage ratio of 5%, but the FSA has declined to so, without giving a reason. The two institutions have overlapping remits with regard to financial stability, and there is some rivalry. The FSA’s own report on ‘Stability in the Financial System’ is more sympathetic to Sweden’s financial industry, and more accepting of its strengths and resilience, than the vigilance of the Riksbank.
"All in all, the Swedish banking system is large, concentrated and tightly interconnected. In addition, the major Swedish banks have a high proportion of non-stable wholesale funding and a low proportion of equity in relation to their total assets. This creates vulnerabilities that make the banking system, and thereby the entire financial system, sensitive to shocks," the Riksbank states in its latest financial stability report.
Erik Thedéen, director-general of the FSA, strikes a softer note in the foreword to the FSA version, but even he cannot entirely resist some Nordic gloom. "It is only later, after the sun disappears behind the clouds, that the mood changes," he says.
