STOCKHOLM (Reuters) – Sweden’s four largest banks use a risk calculation for their loan portfolios that critics say is flawed and leaves them vulnerable to any correction in the booming real estate market.
Nordea NDA.ST, Bank of Sweden SWEDa.ST, SEB SHBa.ST are among the best capitalized banks in the world and survived the 2008 financial crisis unscathed, compared to other European banks.
Swedish home prices fell slightly during the crisis, but have more than tripled in the past 20 years, due to low interest rates, debt tax breaks and weak construction. Swedish households are now among the most indebted in Europe
Encouraged by soaring prices, banks have stocked up on mortgage loans. They now represent nearly 65% of the big four loan portfolios, according to the Swedish Financial Supervisory Authority (FSA).
Although they have increased their home loans, the capital situation of lenders also appears to have improved.
But critics, including Sweden’s central bank and the International Monetary Fund, say this is because since 2007 banks have been allowed to use a model where they self-assess the risk of their portfolios based on historical losses. on loans.
With the housing sector making up such a large part of Swedish lending, losses have been low for a long time. This means that the amount of capital that banks must reserve against future deficits has also been set very low, so they haven’t built enough buffers to make up for larger losses, they say.
“They haven’t (increased their capital). They reduced the risk weights and it’s quite different because the leverage ratio has been almost constant, ”Swedish central bank governor Stefan Ingves said in December.
Since 2010, Swedish banks have doubled their Common Equity Tier 1 ratio, a measure of how much money a bank has in relation to risk-weighted assets, to around 24%, above the EU average of around 13%.
But the leverage ratio, the relationship between the bank’s capital and its total assets, whatever risk you assign to them, has remained virtually unchanged at an average of around 4%.
Banks put less weight on loans that are least likely to fail and put less money aside to cover losses on those loans. The idea is that this serves as an incentive to reduce risk in loan portfolios.
Spokesmen for Swedbank, SEB and Handelsbanken declined to comment on the risk weights.
Nordea’s head of investor relations, Rodney Alven, said: “What drives us to favor risk-adjusted models is that they have taught us a lot about how to manage, minimize and to price the risk correctly. We believe these models have actually reduced risk in the banking system.
“We think we are very well capitalized in all the ways you measure,” he added.
SELF-ASSESSMENT IN LIGHT
Swedish banks often deplore a higher regulatory capital charge than their European counterparts. Sweden has tried to take a benchmark approach to capital buffers to preserve the reputation of banks as strong institutions and because of the importance of the financial sector to the economy.
Only Switzerland and the Netherlands have a larger financial sector than Sweden in the European Union relative to the size of the economy.
Self-assessed risk weights are widely used in Europe, but Sweden’s are among the lowest, according to the IMF in a 2016 report.
Ingves, who was tasked with cleaning up the Swedish banking system after the crisis of the 1990s, says it’s time to put the brakes on the banks. He called for a leverage ratio requirement to balance creative internal models.
“It has been proven since the inception of the system that banks have too much freedom to decide their risk weights and this needs to be revised,” Ingves said.
His sentiment is shared by the IMF which wrote in its report that “available models may suffer from over-reliance on recent historical experience and have difficulty capturing unexpected losses occurring in extreme but plausible scenarios.”
Internal models are also coming under scrutiny in other parts of the banking world as the Basel committee tries to agree on a floor for how banking risks can be lowered. Final levels are expected at the end of the month and could see Swedish banks having to set aside more capital against their loans.
The Swedish Bankers Association says these models remain the best way to capture risk.
“If you try to have a single standard for all banks, the best-functioning banks get the most punishment,” said Johan Hansing, CEO of the association.
“All Swedish banks are highly rated by rating agencies. If there were weaknesses and loopholes in the internal models of Swedish banks, professional actors such as rating agencies would detect it.
The Riksbank says that international surveys have shown that there are major differences in the risk weights of banks, even for identical portfolios. He advocates a leverage ratio requirement of 4% now and an increase to 5% by 2018.
The FSA, responsible for financial stability in Sweden, agrees that the rules have been too lax.
“We partly agree with this criticism and that is why we have tightened the rules,” said Swedish FSA general manager Erik Thedeen. “But it’s too simplistic to say that just because accumulated capital relative to assets hasn’t increased, capital hasn’t increased.”
The FSA has taken a number of steps to strengthen the system. A 25% risk-weight floor on mortgages has been introduced and banks are forced to consider every five years a bad rating when calculating loan losses.
The FSA increased Nordea’s capital requirements by SEK 13.8 billion ($ 1.5 billion) in October after a review found the bank underestimated the likelihood of loan losses in its internal models.
When asked if it was wise to let banks regulate themselves given that many crises started with excessive risk-taking on the part of banks, Ingves replied: “Looking back, when you look: no, not really. “
(This analysis has been passed on to correct a typo in the first graph)