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As an open trading economy with a large financial sector, the Swedish government is highly concerned about current developments in the EU. With no plans to adopt the euro itself, it is concerned that a eurozone banking union might limit its ability to regulate its domestic banking sector.
At the same time, Sweden is very worried about open political discussion in the UK as to whether the country might leave the EU altogether. Sweden sees the UK as an ally in the fight for liberal economic ideas against the drift in some parts of the continent towards dirigisme. The prospect of an 'in or out referendum' in the UK raises Swedish concerns of the UK leaving due to populist sentiments rather than after a full consideration of all the facts.
EU worries
Sweden's finance minster, Anders Borg, visited London in January 2013, and made the case for the UK staying inside the EU. “Sweden would be very worried if the UK left the EU," he says. "The UK is a key partner for Sweden and it plays a central role. A EU without the UK would be a weaker union. In particular, the UK plays a role as the financial centre of Europe. I do not think the UK can leave the EU and remain as the financial centre. Sweden does not want to see the UK leave by accident [due to a referendum] so it is important to take this issue very seriously.”
With opinions in the EU becoming increasingly polarised, Mr Borg is also concerned about the march towards a banking union without proper safeguards for countries on the outside, such as Sweden and the UK. Sweden’s financial sector is the equivalent to four times its gross domestic (GDP) and relies heavily on overseas short-term funding with all the inherent risks that that brings. Financial sector regulation is a key issue for the country.
“We can see the logic of the banking union but we have been very critical that not all member countries are being given the same role and position in this," says Mr Borg. "For Sweden it is not possible to join a banking union where in the end the crucial decisions will be made by the European Central Bank [ECB] council consisting of euro area countries. If you go into a difficult banking crisis you will have to share some pain and on such nights – and it usually is nights – it really matters who calls the shots. Sweden cannot join a banking union on those terms.
“Sweden has been fighting for the right to regulate its own banking sector because it has a very large banking sector and it needs tougher requirements, it needs tougher risk weights, it needs tougher supervision. If we are going to cater for the Baltic area [by advancing credit] and have this risk for the Swedish economy, we need to have tough rules for the banks.”
Systemic weaknesses
In a sovereign report on Sweden by Fitch Ratings in 2012, confirming the country’s AAA rating, its financial sector’s dependence on short-term wholesale funding was listed as a weakness alongside high private sector debt and Sweden’s position as a net external debtor, also due to the liabilities of the banking system.
“High dependence on short-term wholesale funding exposes the Swedish banking sector to financial market volatility,” said the report. “These risks are aggravated by the absence of ECB liquidity for Sweden and the krona’s status as only a ‘minor’ reserve currency. However, Sweden does benefit from a deep and efficient covered bonds market and high private sector savings.”
Mr Borg acknowledges that there are vulnerabilities in his country's banking sector and highlights three in particular. "The banking sector is large, household indebtedness and property prices have gone up for 20 years so indebtedness and asset bubble risk are definitely there, and, finally, the banks are highly dependent on wholesale foreign exchange [FX]-based financing. These vulnerabilities have to be dealt with.
“That is why Sweden is pushing its banking sector to maintain higher capital requirements and it will continue along that path towards tighter regulation and making tougher demands on its banks."
Mr Borg is keen to highlight to the country's banks that this is a risky financing option. “[Policy options include] having cash requirements at the central bank or putting a fee on currency reserves because obviously this is something that in the end forces the Riksbank [the Swedish central bank] to move towards a larger currency reserve. The Riksbank has built up reserves over the past few months to deal with some of the vulnerabilities and the banks should pay a bit towards that.
“The government is worried that short-term liquidity is a problem in Sweden given the FX dependence, and it can respond in different ways. It can work with risk weights and capital requirements and it can also do things to counter the risk, such as increasing foreign currency reserves. It will probably try to work with a combination of these measures to try to push the banks to be a little bit more long term and a little bit less risky.”
Treading cautiously
The message the government has been sending to both the Swedish public and the banks is that they cannot rely on property prices continuously rising over the next few years in the way that they have done in the past. Borrowing and lending decisions should be made with this in mind and in 2010 an 85% cap was introduced on the loan to value of new mortgages. From 1995 to 2010, Sweden’s gross private sector debt grew from 156% of GDP to 237%, and with Mr Borg maintaining that Swedish corporate balance sheets are in good shape much of this must be attributable to the household sector. The worry is that the housing market weakens and/or interest rates rise.
In December 2012, Sweden’s finance ministry revised its growth forecasts down in light of the slowdown in the world economy and the recession in the eurozone. As a small, open trading economy Sweden is vulnerable to external shocks and saw its economy shrink 6% in the depths of the crisis in 2008 and 2009.
Mr Borg fears that crisis could return in the eurozone. “I am a little bit worried that the crisis might come back. I think 2013 will be a very bleak year. There are some serious political circumstances not only in Europe but in the US where there is the fiscal cliff. I do not think that it can be ruled out that the Greek and Spanish problems may come back to the markets so I would still be on the more cautious side. But obviously Europe should try to push for growth as much as it can.”
But should that be done by fiscal measures from strong countries such as Sweden – with its budget deficit likely to be just 1% in 2013 and a debt-to-GDP ratio of 40% – or by the actions of the ECB?
Mr Borg says: “I am very supportive of the ECB taking a strong stance to stabilise the market. In fact, that is the key game changer that has happened in the past six months. Given that there is no risk to price stability that I can see in the foreseeable future, I think there is room for an active and flexible ECB to continue to stabilise the situation.
“Some countries such as Sweden have a stronger fiscal position. Sweden has done a stimulus programme of almost a percentage point of GDP for 2013, cut corporate taxes down to 22% and increased its infrastructure spending, for example, and the country would consider the same for 2014 if it sees continuous weak growth. There are some other countries that could push in the same direction but some of the [eurozone] counties have to fulfil the commitments that they have already made. In their case, consolidation is necessary to re-establish market confidence.”
Picking up the bill
One element of the banking union that is causing controversy is whether funds from the European Stability Mechanism (ESM) can be used to bail out banks as was done in the Spanish case. While this at one time appeared to be in prospect, Germany and other creditor countries have more recently indicated that responsibility for bail-outs should stay with the national treasury.
Mr Borg endorses this view and is also in favour, from the point of view of expediency, of putting government’s on the hook for bank losses rather than bondholders. “Sweden does not think that Swedish taxpayers’ funds should be on the table [for cross-border bailouts]," he says. "It believes that Swedish bank clients should not be worried about deposit insurance taking money out of sound banks and bailing out bad banks. A banking crisis – and there is some experience of dealing with one in Sweden [in the early 1990s] – should be solved by the government taking over banks and recapitalising them through Tier 1 capital and being open and transparent during the process. There could be more progress made by some of the more vulnerable countries on this issue.”
Mr Borg says bail outs should be done by national governments. “Obviously the ESM can provide resources to a government but if it is going to recapitalise banks directly, which it could do, then it must also take them over and there must be an acceptance that Irish or Spanish banks are owned by a Brussels institution. I am not sure whether the countries concerned are willing to accept that.”
On the issue of whether bondholders or taxpayers should pick up the bill for a bank bailout, Mr Borg says: “I can understand [the concerns] from a moral point of view. But the vulnerability of banks [in a crisis] is liquidity and financing. So if bondholders [are forced] to take a haircut, there is quite a risk that it would reinforce a negative spiral and the liquidity and financing issues become even more difficult. If you are ready to recapitalise a bank and take it over you will get your money back. If you own the bank, you can deal with the problems and then return it to the market.
"Sweden put some 3% to 4% of GDP into the country's banking sector [during the 1990s crisis] and got everything back. Sweden actually made money on all of its banking rescue operations. If the Irish are dealing with this in a sound manner they will also get their money back.”
