Riksbank `Rapped Over Knuckles' After Downgrading Covered Bonds

Sweden’s debt office and financial watchdog have lashed out against the central bank, blaming it for failing to check with them before proposing tougher collateral rules on the covered bonds that back the nation’s overheated housing market.

The unusually sharply worded rebuke amounts to the central bank’s being “rapped over the knuckles,” Michael Grahn, an analyst at Danske Bank in Stockholm, said in a phone interview on Friday. “It’s remarkable that they shoot down the Riksbank’s analysis completely.”

In a joint letter published on Friday, the regulator and debt office responded to an October proposal by the Riksbank that essentially downgraded the credit quality of covered bonds. The two agencies said the plan won’t achieve the central bank’s stated aim of lowering its credit risk given that covered bonds carry the highest ratings. They also questioned the motivation behind the decision.

“It’s a real reprimand,” Grahn said.

Bjoern Bargholtz, head of bank policy at the FSA, said the implications of the Riksbank’s proposal for financial stability “need to be investigated further and discussed in the Financial Stability Council.”

The Riksbank, which is focusing its monetary policy efforts on reviving inflation, has long warned that Sweden’s property and mortgage markets are overheated, and has blamed the regulator for doing too little to address the risks.

Its October proposal entails tightening collateral rules back to levels in place before the financial crisis of 2008. The Riksbank also no longer wants to accept as collateral covered bonds that are issued by a counterparty and plans to introduce a concentration limit of a maximum of 60 percent in covered bonds as a share of a counterparty’s total collateral.

“When the Riksbank released the proposal, our reaction was that it’s an attempt to step into macro-prudential policy through the backdoor through driving up mortgage interest rates, and that it’s barging into another authority’s area,” Grahn at Danske Bank said.

Since the bank put forward its proposal, spreads on covered bonds have widened. The asset swap spread on Nordea’s 2 percent 2018 covered bond was about 43 basis points at the end of last week, compared with a low of 21 basis points in August.

Sweden’s covered bonds are used to finance mortgages in a market that the central bank, International Monetary Fund and others have warned may be close to a tipping point.

Riksbank Governor Stefan Ingves said on Thursday that the price development in the housing market poses risks to both the real economy and financial stability. Given that the central bank has already resorted to negative rates to drive inflation closer to the bank’s 2 percent target, it is “essential” to ensure that mortgage risks don’t build up, he said.

Hans Lindblad, head of the Swedish Debt Office, and Erik Thedeen, who heads the regulator, said the Riksbank’s proposal seems intended “to affect financial stability.”
It was “remarkable” that the central bank didn’t discuss the plan with the Financial Stability Council, they said.

Fredrik Wange, a spokesman for the Riksbank, declined to comment on Friday.

In an interview with Svenska Dagbladet last week, Ingves said the housing market is growing more dangerous every day and called covered bonds the “linchpin” of the Swedish financial system. In the minutes of the bank’s latest rate meeting, Ingves reiterated his opinion that Sweden needs two policy rates, one that targets companies and one that steers developments on the housing market.

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