Banking Risks Spur Talk of 20% Buffers in Sweden

Sweden’s economic elite are debating whether governments with oversized bank industries need to demand even tougher capital standards than those agreed after the latest wave of regulatory tightening.

Sweden’s requirement that its four biggest banks hold at least 10 percent in core Tier 1 capital of risk-weighted assets this year, and a minimum of 12 percent from 2015, marks one of Europe’s most stringent regulatory overhauls. Yet some of the nation’s most influential economists now argue those rules may be too weak to protect the economy from losses.

“Ideally, the capital requirements for banks should be raised substantially,” Assar Lindbeck, a research fellow at the Research Institute of Industrial Economics, said yesterday in an interview. Lindbeck is one of the main architects behind Sweden’s budget surplus rule and a former chairman of the Nobel Economics Foundation that selects laureates every October. He says a capital buffer as high as 20 percent might be called for.

While AAA Sweden boasts a debt level that’s less than half the euro-area average, the government should consider relying less on borrowed funds to guard against financial risks, Hans Lindblad, director-general of the debt office in Stockholm, said last week. Nations with large bank systems are particularly at risk, he said. In Sweden, the four biggest banks have combined assets more than four times the nation’s $500 billion economy.

Cutting Forecasts

Finance Minister Anders Borg, who yesterday cut Sweden’s 2014 economic forecast to adjust to a bleaker outlook in the euro area, said the European Union’s rule limiting debt to 60 percent of gross domestic product is a meaningful target only if it’s not breached during a financial crisis.

After three years of fiscal turmoil, only five of the euro area’s 17 member states will comply with the bloc’s 60 percent debt rule this year, according European Commission estimates published Feb. 22. Germany’s debt will reach 80.7 percent, while the euro area’s average will swell to 95.1 percent of GDP. Greece’s debt burden will be almost three times the bloc’s targeted limit, at 175.6 percent, the commission estimates.

Commission data also show euro-zone governments have injected 1.7 trillion euros ($2.2 trillion) into their banking systems since 2008 as the fates of nations depended on the survival of their financial industries.

Spreads Widen

Sweden’s benchmark 10-year note yields about 42 basis points more than benchmark German notes, widening from 21 basis points at the start of the year. Nordea Bank AB’s 4.625 percent euro note maturing in 2022 yields about 202 basis points more than the euro government benchmark curve, little changed from the start of the year.

Borg, who this week cut Sweden’s economic growth estimate by 0.8 percentage point to 2.2 percent for 2014, said yesterday 40 percent of GDP is a safer debt threshold than 60 percent for nations with large bank industries.

Sluggish economic growth means the government of Prime Minister Fredrik Reinfeldt will post a budget deficit in both 2013 and 2014, Borg said. The shortfall will reach 1.6 percent of GDP this year and narrow to 1 percent in 2014. Sweden’s budget will be in balance in 2015, he said.

“We should have a debt with a significant safety margin,” Borg said yesterday. “We should be a banking crisis and a weak economy away from 60 percent debt.”

Job Losses

The government isn’t planning additional measures to reduce debt as it focuses on creating jobs, Borg also said. While debt should come down “at some point,” the government can’t cut its borrowing when unemployment is still high, he said. Sweden’s jobless rate will average 8.4 percent this year, the highest in Scandinavia.

Sweden’s total debt burden, including borrowing by municipalities, will reach 42 percent of GDP this year, the Finance Ministry estimates. Debt will ease to 41.8 percent of GDP next year and 39.5 percent in 2015, it said. Debt by that measure was 38.2 percent in 2012.

According to Lindbeck, much of the work to protect taxpayers from banking industry risks should be done through stricter capital rules and curbs on investor rewards.

“I can imagine the possibility of putting a stop to dividends for a couple of years to build up capital buffers to between 15 percent and 20 percent,” he said. “That may possibly raise interest rates, but we have to accept that. It’s much worse if we end up with a banking crisis.”

Haven Trade

Sweden, which emerged as a haven from the current wave of global turmoil, is determined to avoid a repeat of the nation’s 1990s crisis that ended with the nationalization of two of its biggest banks. After global financial markets went into a panic at the end of 2008, Sweden introduced a 1.5 trillion-krona ($235 billion) government guarantee program to secure funding for its banks.

Of Sweden’s biggest lenders, only Swedbank AB used the guarantees while SEB AB signed up for the program without using it. Both banks suffered record loan losses from their units in the Baltic states when housing bubbles led to Europe’s deepest economic declines in Latvia, Estonia and Lithuania in 2009.

Banks have so far amassed more capital than the regulatory minimum. Nordea’s core Tier 1 capital ratio reached 13.1 percent of risk-weighted assets at the end of last year, while Swedbank’s was 17.4 percent and SEB’s was 15.1 percent. Svenska Handelsbanken AB had a ratio of 18.4 percent in the final three months of 2012. The results put Sweden’s biggest banks at the top of capital rankings in the EU. Even those levels may still leave room for losses, given the unstable nature of banking, Lindbeck said.

“The banking business is risky since it lends other people’s money and you then need a sizable buffer,” Lindbeck said. “It’s a misconstruction in the world’s banking system that they’re working with so little capital.”

Before it's here, it's on the Bloomberg Terminal.