Bank Bail-In Laws Leave Swedish Escape Clause in S&P Analysis

Europe’s single rule book says taxpayers shouldn’t be forced to rescue banks. How best to protect them is described in the Bank Recovery and Resolution Directive, which took effect in January last year.

But Standard & Poor’s says it assumes there’s one European Union country that wouldn’t have the stomach to test a big bail-in, and that country is Sweden.

“Sweden has a large banking sector that’s inter-connected, and any risk to one bank would potentially spread to peers and then could threaten financial stability, which is a precondition for pre-emptive support,” Alexander Ekbom, a bank rating analyst at S&P in Stockholm, said in a phone interview.

Sweden’s four biggest banks have combined assets that are about four times the size of the country’s economy. So letting part of that system fail “could be more costly than providing funds pre-emptively,” Ekbom said. “This is one of the reasons why we still consider the government supportive and include government support in our ratings, which we don’t elsewhere in Europe where BRRD has been implemented.”

Here’s an overview of some European bank ratings at S&P:

To be sure, Sweden’s biggest banks are some of Europe’s best capitalized, after regulators ensured they were well enough padded for the risk of insolvency to be as remote as possible. What’s more, the cycle of regulatory reform that followed the global financial crisis means few supervisors are going to let their banks get anywhere near the capital thresholds that would trigger some sort of bail-in procedure, according to Ekbom.

The theory also applies to the riskiest bank bonds, known as additional Tier 1 notes, which come with clauses that can force issuers to restrict dividend and coupon payments if regulatory capital drops below a given level.

“It would be a rare occasion when the FSA would allow a bank to burn through 500 basis points of capital before asking them to address the problem and stopping coupon payments,” Ekbom said.

Supervisory authorities in Denmark, Norway and Sweden are giving banks more leeway to breach capital thresholds than the London-based European Banking Authority recommends. More specifically, AT1 investors in Scandinavian banks won’t see their dividends or coupons automatically restricted should an issuer’s capital drop below a level that includes a so-called Pillar 2 threshold, which is set by local regulators and sits on top of minimum standards, known as Pillar 1.

Scandinavian regulators argue their model means that banks in need of fresh capital will have an easier time tapping markets if they haven’t just angered investors by withholding payments. The region’s FSAs also note that they reserve the right to step in and suspend payment in specific cases.

It’s an argument that resonates with S&P. Ekbom says restricting payments “could create market nervousness, meaning a bank potentially wouldn’t be able to issue additional instruments and even more of their funding structure could be impacted.”

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