Banks With Most Equity Penalized as Sweden Girds for TLAC

To protect its economy, Sweden three years ago began imposing on its banks some of Europe’s toughest capital requirements, including orders to fill buffers largely with equity.

The Nordic country, whose lenders have assets almost four times the size of its gross domestic product, may have acted too swiftly.

Global regulators have proposed rules that favor debt over equity to ensure the world’s biggest lenders have enough liabilities to bail in and avert a government rescue from insolvency, according to the Swedish Bankers’ Association.

The country’s lenders may now be forced to alter their funding strategies if the Financial Stability Board’s total loss-absorbing capacity requirement is adopted, according to Johanna Orth, senior adviser at the Stockholm-based association.

“There’s a risk that the major Swedish banks will have to change their funding plans if the legislative process at the EU and national level means TLAC requirements apply to Swedish systemically important banks,” Orth said.

Sweden’s banks have emerged as among the best capitalized major lenders in Europe, measured by core Tier 1 ratios, after the country’s government, central bank and regulator agreed on requirements that are more than double the European minimum of 8 percent of risk-weighted assets.

Equity can absorb losses better, the Financial Supervisory Authority said today in its biannual report on financial stability. Sweden plans to allow banks to use equity if they choose to meet the requirement for additional bail-in-able liabilities.

Practical Implications

Yet according to Orth, “regulation such as TLAC that focuses on boosting liabilities that absorb losses is therefore a different model and will have practical implications for Sweden’s banks and the FSA.”

The European banking industry is just beginning to sort out what TLAC and a corresponding regional requirement for minimum loss-absorbing capital, or MREL, will mean. The FSB introduced its proposal last month, as did the European Banking Authority. Final recommendations will be made next year.

There’s a lot of confusion over where levels will be set, what instruments banks are probably going to use and where those securities will be placed in the hierarchy of which creditors would be wiped out and when in the event of a collapse.

“The estimates of how much has to be raised are just all over the place, because they don’t really know what the banks are going to do and the banks themselves don’t know what they’re going to do,” said Laurie Mayers, associate managing director at Moody’s Investors Service.

Systemic Risks?

The Swedish FSA recommended today that bail-in requirements be set at “appropriate levels” and that they shouldn’t be equated with minimum capital requirements. It urged too that breaches be met with “reasonable” consequences.

Otherwise, “new systemic risks can be created if major banks in funding difficulty risk losing their license at an early stage,” the FSA said.

Among the Swedish banks only Nordea Bank AB, based in Stockholm, is considered a globally significant bank and therefore subject to TLAC. Swedish regulators prefer to treat the country’s largest lenders similarly, so they could apply the requirement to the rest, Orth said.

“A lot of negotiations and discussions will take place before that is clarified,” she said.

Confusion Abounds

European banks will have an easier time meeting the MREL than TLAC, Paul Fenner-Leitao, an analyst at Societe Generale, said in a Dec. 2 note. That’s because the requirement doesn’t explicitly exclude banks from using senior unsecured debt while TLAC does unless it’s subordinated to operating liabilities, he said.

The difference between the two proposals also means that banking groups with holding company structures look more robust, Orth said.

“Because of the eligibility of holding company debt for TLAC, the general impression is that American and British banks are in a stronger position given they already have this structure in place,” Orth said.

Banks that meet MREL requirements should also be considered to have met TLAC, Orth said.

The current capital requirements have led to a “very high degree of confidence” in Sweden’s banks, Orth said. “Now the U.K. and the U.S. are promoting TLAC instead. We wouldn’t know which model is the better one -- until the next crisis occurs.”

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