Bank Risks Hidden From Investors to Be Disclosed in Sweden

Sweden will start publishing banks’ individual capital requirements in a step designed to reveal risks investors have so far been unable to measure based on reported buffers.

The Swedish Financial Supervisory Authority is planning to follow its Danish counterpart and disclose so-called Pillar 2 requirements as Scandinavia leads Europe in stepping up efforts to improve transparency. In Denmark, which like Sweden has a bank industry whose assets are four times gross domestic product, lenders can be shut down by the regulator if reserves drop below individual requirements.

Disclosing bank-specific capital needs, which are set by national regulators, isn’t required under Basel III or European capital rules. Pillar 2 requirements can in some cases more than double the minimum amount of equity and debt a bank must hold to absorb losses. The Basel Committee on Banking Supervision sets out three Pillars for a sound financial system. The first imposes industrywide capital requirements, and the third draws on market discipline by forcing banks to show how they meet those requirements.

Failure to tell investors a bank’s individual capital requirement is “certainly sub-optimal,” Johan Eriksson, senior adviser for bank policy at Sweden’s FSA, said by phone. Pillar 2 affects “significant parts of banks’ capital requirements,” he said.

Important Constraints

“Ideally, the banks’ aggregate capital requirements would be disclosed as they clearly represent important constraints on any bank’s capital policy and may impact risks to investors more broadly,” Eriksson said.

The layers of capital that regulators can force banks to hold have multiplied as policy makers seek to avert a repeat of the global financial crisis. Efforts to rein in bank risk have touched on the industry’s systemic role in the economy to preventing lenders understating the probability of losses by imposing stricter risk weights on assets.

Sweden already requires its biggest banks to meet some of the world’s most rigorous capital standards, ranging from 14 percent for Nordea Bank AB to 19 percent for Swedbank AB. In May, the FSA said banks should hold a 1 percent counter-cyclical buffer after household debt burdens swelled to a record.

Greater disclosure in general will aid market discipline, according to Ross Levine, a professor at the University of California at Berkeley’s Haas School of Business and co-author of “Guardians of Finance: Making Regulators Work for Us.”

Bank Runs

“The often repeated -- but never substantiated -- argument is that revealing information could cause depositors and other liability holders to ‘run’ on the bank, remove their funds, and potentially cause a failure,” Levine said in an e-mailed response to questions. “The primary reason for non-disclosure is that banks do not want to be disciplined by the market and manipulate regulators to help them keep information private.”

The Basel Committee recommended changes last month to its Pillar 3 disclosure framework to make it easier to compare banks. The committee said information on how banks went about risk weighting was particularly “inadequate.”

The financial crisis showed the disclosure requirements “failed to promote early identification of a bank’s material risks and did not provide sufficient information to enable market participants to assess a bank’s overall capital adequacy,” the committee said in the June report.

Proper Analysis

Investors aren’t the only ones unable to make a proper analysis of how well a bank’s reported capital buffer reflects its individual risk profile. Standard & Poor’s argues that assessing a bank’s health can be difficult without knowing a lender’s Pillar 2 requirement.

Disclosure of total requirements “would be a feature that would be helpful for the market to make comparisons,” Alexander Ekbom, an analyst at S&P in Stockholm, said by phone. “To my knowledge, Denmark is the only country that publicly discloses Pillar 2 requirements.”

Denmark requires banks to disclose individual solvency needs on top of an 8 percent minimum capital requirement relative to risk-weighted assets. If capital falls below a lender’s individual requirement, the FSA can shut down the bank in question if it’s unable to raise capital or find a buyer.

Bank Closures

Sweden’s FSA in May released approximate figures for banks’ total requirements using standardized add-ons for certain risks, Eriksson said. They include interest-rate risk, loan concentration and pension risks.

The agency will release final figures after adopting new methods for calculating the add-ons and imposing them on a firm-by-firm basis, he said. The FSA is seeking public comment on the methods, which are still under development.

“The Danish environment has probably been the most transparent, given that the Pillar 2 add-ons have been published by the banks themselves,” Eriksson said. “That has not been the case elsewhere, although some banks have published their Pillar 2 requirements also in other EU countries.”

Among the reasons for the lack of disclosure globally has been an absence of uniform approaches to addressing the risks, he said. New guidelines proposed by the European Banking Authority earlier this month may help bridge the gap, he said.

“One would expect increased disclosure as well” as methods are harmonized, Eriksson said. “It is such an important parameter for investors more broadly in instruments issued by banks, whether it is shares or fixed-income instruments.”

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