Sweden
Financial Sector Stability Assessment

The impact of the financial crisis on Sweden’s economy and financial sector is analyzed in this study. From the financial stability analysis, banks are resilient to credit risk and could face difficulties with respect to liquidity risk. The frameworks of international reserve management and Riksbanken’s (RB’s) are reviewed by authorities. The existing framework is augmented by the high-level systemic financial stability council (SFSC) to coordinate financial stability policies and actions. The authorities will strengthen the Finansinspektionen (FI)'s resources and legal frameworks for bank resolution and security markets.

Abstract

The impact of the financial crisis on Sweden’s economy and financial sector is analyzed in this study. From the financial stability analysis, banks are resilient to credit risk and could face difficulties with respect to liquidity risk. The frameworks of international reserve management and Riksbanken’s (RB’s) are reviewed by authorities. The existing framework is augmented by the high-level systemic financial stability council (SFSC) to coordinate financial stability policies and actions. The authorities will strengthen the Finansinspektionen (FI)'s resources and legal frameworks for bank resolution and security markets.

I. Background

A. Macroeconomic and Financial Setting

1. The global financial crisis severely affected Sweden’s economy causing a deep recession, but the economy has rebounded strongly (Table 2). Swedish GDP contracted by 7½ percent from the second quarter of 2008 to the second quarter of 2009, the krona depreciated by close to 20 percent against the euro, equity values halved, and unemployment rose from 6 percent to nearly 10 percent. Since mid-2009, the economy has rebounded, with real GDP growth reaching 5½ percent in 2010. Public finances remain the strongest among advanced economies, with the fiscal balance projected to return to surplus in 2011.

Table 2.

Sweden: Selected Economic Indicators, 2005–11

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Staff Estimates

Based on relative unit labor costs in manufacturing.

Sources: Statistics Sweden; Riksbank; Ministry of Finance; Datastream; INS; and IMF staff estimates.

2. The impact of the financial crisis on Sweden’s financial sector was significant. The crisis led to some strains in various segments of funding markets, including in euro and dollar liquidity. In particular, due to extensive reliance on short-term wholesale funding, coupled with increased market concern about exposures to the Baltics, several Swedish banks faced acute funding pressures.1 The non-banking financial sector was also adversely affected: the solvency ratio of insurance companies fell on the back of falling equity prices,2 while mortgage bond yields rose to unprecedented levels relative to comparable government bond yields.

3. The authorities’ forceful policy response helped restore confidence. The RB implemented new liquidity measures through expanding its balance sheet, and took a number of steps to support banks’ liquidity needs and reassure markets (Box 1). At the same time, the Government Support to Credit Institutions Act was enacted in October 2008 to deal with distressed systemically important institutions; the Swedish National Debt Office (SNDO) borrowed externally to boost international reserves; and the RB used swap lines established with the ECB in 2007 and the U.S. Federal Reserve in 2008. Meanwhile, banks strengthened capital positions through right issuance. These policies were successful in restoring market stability, and financial sector strains eased by the mid-2009.

4. Nonfinancial corporations have rebounded from the recent crisis. Corporate financial positions strengthened during 2010, particularly for large export-oriented companies. Moreover, banks’ exposure to the corporate sector is much lower than during the 1990s crisis—the share of corporate loans in banks’ total loan portfolio has fallen to 22 percent, while the household share has risen to 34 percent.

Key Crisis Intervention Measures

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5. Reflecting improved market conditions and the economy’s rebound, the authorities began, in April 2010 to exit from crisis-response measures. The RB has terminated the extraordinary liquidity measures, the size of its balance sheet has shrunk markedly, and the policy rate has risen 150 basis points in total to 1.75 percent. Nonetheless, risks remain, stemming from a highly concentrated banking sector with important foreign activities and continued reliance on wholesale funding, including in foreign currencies.

6. House prices and household indebtedness have risen steadily over the past two decades, prompting concerns about their sustainability. Prices rose by some 40 percent from 1995 to 2010, and unlike elsewhere, did not correct following the recent crisis. However, the pace of growth has slowed recently. This follows the imposition of an 85 percent loan-to-value ceiling in October 2010 and the policy rate increases since July 2010. Household debt has increased by twofold since 1995 and the share of variable interest rate debt rose from below 10 percent to 50 percent of the total outstanding stock, with younger and low-income households most vulnerable to interest rate increases (Figure 1).

Figure 1.
Figure 1.

Sweden: Household Debt as share of Disposable Income

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

Source: Haver Analytics

7. Household lending has historically not generated significant losses for the financial system. Mortgage credit quality is high owing to several structural features of the Swedish housing market. The highly regulated covered bonds market through which mortgages are financed provides incentives for lenders to engage in selective mortgage origination. The Swedish bankruptcy law makes it difficult for borrowers to “walk away” from their debt. By law, a borrower is personally liable for life, even after a default and foreclosure procedure has been initiated by the bank. A well-developed and generous social welfare system implies that households’ ability to service debt does not necessarily deteriorate during periods of unemployment. Further, the absence of a speculative “buy-to-let” market due to a highly regulated rental market and tenant owner subletting restrictions has prevented the development of a speculative bubble.

B. Implementation of 2002 FSAP Recommendations

8. The 2002 FSAP assessment revealed that overall Sweden had a sound financial system, although weaknesses in the regulatory and supervisory framework were identified. Of specific concern were deficiencies in observing the core principles dealing with the oversight of “fit and proper” rules and propriety of the management of banks and insurers, the extent of consolidated supervision and on-site inspection process, loan provisioning, connected lending, and remedial actions. Furthermore, the FI lacked sufficient resources to carry out effective supervision and the power to take interim or corrective action measures.

9. Implementation of these recommendations has been mixed. The authorities have made progress in many areas such as consolidated supervision and cross-border supervision and cooperation. Nevertheless, progress needs to be made to: further increase FI’s resources in order to ensure effective supervision; enhance licensing requirements, including “fit and proper” test to senior management; and establish an appropriate crisis management and bank resolution framework (see Appendix I).

II. Financial Stability Assessment

A. Financial Stability and Risk Factors

10. The Swedish financial sector is sizeable and dominated by systemically important institutions. The financial system’s assets are equivalent to 5½ times of GDP. The four largest banks—Swedbank, Nordea, SEB, and Handelsbanken—account for 86 percent of banking sector assets. Banks’ lending is predominantly in Sweden and other Nordic countries, although cross-border exposures also exist in the Baltics (Figure 2). The insurance sector is well developed and accounts for 14 percent of financial sector assets. The top five life insurers accounted for 61 percent of assets of the life sector as of end-2009, and the top five nonlife insurers have about 55 percent market share of gross premiums written in 2009. All major banks have insurance subsidiaries and some large insurers have bank subsidiaries. In addition, there are mortgage and other credit market companies, some of which are bank subsidiaries, that also extend credit.

Figure 2.
Figure 2.

Sweden: Loan Geographic Distribution

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

11. The financial position of the four largest banks appears robust. Capital adequacy ratios (CAR) are well above the regulatory minimum levels, supported by solid profits and recapitalizations which took place in late 2008/09 through rights issues. Banks’ profits rebounded from their 2009 lows arising from losses in the Baltics.

12. While the life and nonlife insurance sectors have different risk profiles, both are exposed to developments in global financial markets through their sizable foreign investments (32 percent of total assets of the industry). Life insurers have higher levels of investments in equities, and are particularly vulnerable to low interest rates. Nonlife insurers write a significant level of foreign risks (34 percent of gross premiums in 2009), and face intense competition that weight on premium rates.

13. Sweden has well developed financial and securities market infrastructures. In 2009, the RB introduced a state-of-the-art funds transfer system (named RIX). Further, the Swedish Central Securities Depository (CSD) merged with Euroclear Group. NASDAQ OMX runs the Swedish stock exchange, the derivatives exchange and the electronic inter-dealer exchange for certain government bonds. This same entity acts as the central counterparty (CCP) for derivatives and repo transactions. During the crisis, these systems were resilient and were able to handle the increased numbers of transactions.

14. Sweden is a regional banking hub. Its significance rests more in its role as a home than as a host jurisdiction. However, since fewer than half of the consolidated assets of the systemic groups are located in Sweden it has a critical role to play in ensuring the financial stability of the region. Sweden has responded actively to the challenges of its position though its proactive home-host arrangements, making full use of the opportunities created by the EU legislative framework with respect to its work within colleges of supervisors.

15. Vulnerabilities in the banking sector arise from exposures to:

  • Renewed global recession. As a small open economy, with large trade sector and external financial sector linkages, Sweden is highly exposed to the global economy. Global recession would adversely affect bank asset quality through various transmission channels including increased unemployment, deteriorating corporate earnings, and a sharp correction in real estate prices.

  • Funding risks. Banks rely heavily on short-term wholesale funding, which makes them vulnerable to market disruptions and liquidity risk. Banks’ mortgage lending is largely funded through the covered bond market (mostly in SEK). Some banks seize arbitrage opportunities by contracting cheaper short-term foreign exchange debt in the wholesale markets, which they then convert to SEK to finance mortgages. This funding structure poses vulnerabilities to the banking sector if such markets dry up or their cost increases sharply, including in response to a shift in investors’ risk appetite.3

  • Cross-border lending. Banks’ lending is predominantly in Sweden and other Nordic countries. Around 4 percent of total loans are in the Baltic countries, where Swedbank and SEB have the largest exposures (approximately 10 percent).

  • Sustained declines in real estate prices. Housing and property developers’ loans account for 60 percent of total lending.

B. Stress Testing Vulnerabilities in the Banking Sector

16. A wide range of stress tests were performed on the largest four banks that account for 90 percent of the banking system’s total assets.4 The stress tests were performed in close collaboration with the RB and FI and include:5

  • Macro stress tests covering four scenarios.

  • Liquidity stress tests.

  • Contagion stress tests.

17. Top-down macro stress tests were conducted by the mission and Riksbank (RB) for the four largest banks under four macro scenarios; these are:

  • a baseline scenario in line with the October 2010 World Economic Outlook (WEO) projections for GDP growth of 2.56 percent in 2011 and 3 percent in 2012, as well as conservative projections for, unemployment, and interest rates;

  • a double-dip scenario implying increase in unemployment and interest rates, and assuming deviations in GDP growth by 2.7 percentage points in 2011 and 3.2 percentage points in 2012 compared to the WEO baseline;

  • a more severe double-dip scenario assuming twice the deviations from baseline for the macroeconomic and EU sovereign bond market shocks; and

  • a prolonged low-growth scenario, including a house-price crash inducing a decline in domestic consumption (Figure 5).

Figure 3.
Figure 3.

Sweden: Financial Soundness Indicators in Cross-Country Comparison, 2010

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

Source: GFSR
Figure 4.
Figure 4.

Sweden: Market Indicators for the Four Major Banks, 2007–10

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

Source: Bloomberg, Markit, and IMF staff estimates
Figure 5.
Figure 5.

Sweden: Macroeconomic Assumptions in Macro Stress Tests

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

Source: Riksbank and IMF staff estimates

The exercise spanned five years and combined potential losses from three sources: loan losses from credit risk, valuation losses from sovereign exposures held both in the banking and trading book, and losses from funding cost increases.

18. Under the four scenarios, banks showed resiliency. Despite weak growth and high unemployment assumed under the scenarios, and subsequent increases in bank losses during the crisis years, banks’ capital ratios remain above the 4 percent Tier 1 regulatory minimum, the 6 percent CEBS threshold, and the 8 percent total CAR regulatory minimum under both the FSAP and RB models (Tables 6). Shocks to sovereign bond portfolios and funding costs do not have a major impact, given banks’ limited sovereign bond exposures6 (including both the banking and trading books), in particular to the vulnerable European countries, and the assumed high degree of pass through of increased funding cost.7 Moreover, post-shock credit losses are not significant given banks’ high quality loan portfolios and low initial values of credit risk measures. Strong operating profits and large loan loss provisions built-up during the crisis also serve as first line buffers against the losses.

Table 3.

Sweden: Structure of the Financial System

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Sources: Riksbank, Financial Supevisory Authority, and IMF staff estimates.

Including foreign branches.

Not including minor local companies

Market value of funds

Number of institutions is computed on unconsolidated basis.

Table 4.

Sweden: The Core Set of Financial Soundness Indicators (FSIs) for Banks, 2003–11

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Sources: Financial Supervisory Authority, Riksbank, and IMF staff estimates.

From 2007, the calculation of capital base follows rules under Basel II.

On consolidated basis

From 2010 onward, exposures to credit institutions are included.

Table 5.

Sweden: Financial Soundness Indicators Nonbanks, 2003–10

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Sources: Financial Supervisory Authority; Riksbank; and IMF staff estimates.
Table 6.

Sweden: Summary of Credit Risk Stress Testing Results, 2011-15

(In percent)

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Notes: Profits before loan losses, loan losses, and RWA are given in percent deviations from baseline. Tier 1 ratios and total CARs are given in percent.Sources: Riksbank and IMF staff estimates.

19. Liquidity risk stress tests covered both short-term cash outflows and structural maturity mismatches. The tests were carried out by the RB. Two measures similar to Basel III liquidity-coverage ratio and net-stable-funding ratio were calculated. The first measure evaluates banks’ liquidity buffers under stressed scenarios to cover unexpected outflows over three months. Unexpected cash outflows could arise as a result of a drying up of wholesale markets, deposit withdrawals, and a drawing down of unused credit lines (Figure 5). The second measure assesses banks’ structural long-term liquidity relating the weighted average of their liabilities to the weighted average of their assets.8

20. Liquidity stress-test results show that banks lag in both liquidity metrics behind other European banks owing to their heavy reliance on short-term market funding. The short-term liquidity measure is significantly less than 100 percent, suggesting that banks do not have sufficient liquidity reserves to cover modeled cash outflows. The weakness in the structural measure reflects the heavy reliance on non stable, short-term market funding to finance relatively illiquid assets, as well as the large share of banks’ assets in mortgages, which in Sweden are kept on banks’ balance sheets (not securitized, as in some other countries).

21. Large exposures and contagion tests evaluated the impact of concentration risk and interbank exposures as regards unsecured lending, securities, and derivatives. The tests were carried out by the RB.9 The results seem to suggest that banks could withstand the default of a major bank but not the joint default of their three largest exposures. The latter would result in a significant impact on banks’ capitalization, although none of the banks would fall below the limit of 4 percent in Tier 1 capital ratio.

22. The balance sheet stress tests for the four major banks were complemented with tests based on the contingent claims analysis (CCA) framework. The results of the balance sheet stress tests were used to estimate changes in bank assets, and together with the impact from changes in global risk appetite, CCA outputs were calculated for the four scenarios 2011–2015 period. The outputs are: (i) expected losses to creditors; (ii) bank credit spreads; (iii) CCA capital ratio (market value of equity from the scenario output divided by the market value of assets); and (iv) capital shortfall measure. The results, which are qualitatively similar to the results of the balance sheet stress tests, show that in the adverse scenarios, expected losses increase and equity capital decreases until 2012 and then begin to rebound. However, the magnitude of the deterioration is much smaller than in 2009 during the financial crisis, no bank has a capital shortfall in any year of the stress test.10

23. The crisis has revealed a lack of sufficient granularity in data for monitoring financial sector developments. This was evidenced by the lack of consistent sectoral and geographic breakdowns of data on banks’ nonperforming assets. The authorities should regularly collect and monitor loan default rates and nonperforming loans (NPLs) by sector and geographical allocation, in particular housing related loans.

24. Finally, the robustness of the banks’ financial positions is largely attributed, as demonstrated by the stress tests, to current high level capital buffers. Accordingly, the authorities’ plan to accelerate the implementation of Basel III capital requirement, based on the current high banks’ capital level, and to tighten liquidity regulations is appropriate. Furthermore, the authorities’ intention to impose higher than minimum capital requirements on the largest and systemically important banks is a move in the right direction, given the nature of major banks’ exposures and prevailing risks.

III. Macroprudential and Financial Stability Framework

25. Financial stability responsibilities in Sweden are spread across a number of authorities. The FI has a statutory mandate for financial stability and to actively promote consumer protection. The RB, on the other hand, does not have in its charter an explicit financial stability mandate but is responsible for promoting a safe and efficient payments system and has some instruments that are directly relevant to financial stability, including the provision of ELA and systemic liquidity. The MOF bears the ultimate political responsibility as the fiscal authority, but is also responsible for legislation in the financial sector and plays a role in crisis management as public funds might be called upon to support failing institutions. Finally, the SNDO manages the stability fund, deposit insurance and investor protection systems and is the support authority when public funds are conferred to credit institutions.

26. Consideration could be given to establishing a high-level SFSC to focus solely on financial stability and related macroprudential policies. The SFSC would become the focal point for coordinating financial sector policies and actions across agencies. In setting up the proposed council and to ensure its effectiveness, decisions would be needed on the scope of analysis, range of risks to be addressed by the policy, the set of instruments, and institutional and governance frameworks. Consideration could be given to include independent members in addition to the MOF, RB, FI, and the SNDO. It is critical that member authorities are represented at the highest level to ensure effective discussions. Finally, given the legal independence of the involved authorities in carrying out their separate mandates, the SFSC should be consultative in nature requiring, to ensure its effectiveness, clear lines of public accountability (including possibly reporting to Parliament) for discussions, positions, and commitments expressed by members.

IV. Sectoral Regulation and Supervision

27. The assessments of the most relevant financial sector standards and codes show that compliance is generally high, although important concerns need to be addressed.11 In particular, FI’s operational independence, clarity of day-to-day mandate, and insufficiency of resources are overarching concerns, each of which could impair FI’s ability to discharge its supervisory and oversight functions adequately and effectively.12 The operational independence of FI in discharging its supervisory responsibility should be enhanced, including setting its own priorities and work program within its legal mandate by, inter alia, ensuring the appropriations letter is issued only once annually and is drafted in terms of high level principles.

A. Banking

28. The banking supervisory framework and its implementation in Sweden are in line with many of the Basel Core Principles. Since the advent of the global financial crisis, FI has instituted a more robust supervisory approach, which has made important advances on the previous regime and initiated a number of fruitful projects. Nonetheless, FI’s overall capacity to supervise banks, including any meaningful program of on-site inspection, is impacted by a staffing shortage.

29. Not all of FI’s legal powers are as robust or as well developed as they need to be. There are some significant deficiencies relating to the legal framework within which the supervisory authorities operate. These include:

  • the lack of legal basis to assess the fitness and propriety of senior management of licensed firms, or to remove such individuals. FI has powers to assess only the Managing Director, but not the senior executive management;

  • the absence of a pre-notification requirement to FI of major acquisitions made by supervised firms, unless the acquisition is 25 percent or greater of capital base; and

  • although FI has wide powers of intervention in the event that an institution breach its obligations under the Banking and Financing Business Act, FI’s powers of sanction are subject to appeal and the execution of an administrative decision of the FI is suspended until the appellate procedure is completed. While redress and appeal mechanisms are necessary, the current framework creates a degree of regulatory uncertainty and could potentially exacerbate the management of a crisis situation.

30. Progress has been made in consolidated supervision and home-host relationships. FI is active in pursuing and achieving some success in moving beyond pure information exchange into joint supervisory activity, assessment and decision making for the consolidated group, which is a notable achievement. Resources are crucial for further progress in this area.

B. Insurance

31. The Swedish regulatory framework has a high level of observance with the ICPs. The new Insurance Business Act, which entered into effect on April 1, 2011, and the impending implementation of Solvency II will strengthen FI’s supervision, going forward. However, there is scope for improving the coverage, intensity, and intrusiveness of FI’s supervision. Further, the authorities are advised to review the continued involvement of the government in institution-specific supervisory issues.

32. The insurance sector has so far been able to cope with a low interest environment. This is mainly due to the investment-linked policies (ILPs) as policyholders assume all investment risks including interest rate risks. Second, for traditional policies, Swedish insurers have lowered the guarantee levels for new traditional policies issued. While their legacy portfolios carry higher levels of guarantees, there have not been widespread solvency concerns, so far. FI’s Traffic Light model indicated that “insurance companies have good buffers in order to manage their risks.”

33. There is a need for formulating a risk-based supervision approach that is supported by appropriate baseline supervision. FI’s insurance supervisory staffs are competent and qualified. However, due to resource constraints, FI has been focusing its supervision on the larger insurers with minimal attention to smaller insurers and intermediaries. Prudential supervision should be strengthened by fit and proper assessments of senior management of insurers, adequate regulatory reporting, and enhanced group supervision.

C. Securities Markets

34. FI is broadly compliant with international standards but there are certain weaknesses. In particular, the legislative and the regulatory framework limit FI’s independence and its ability to effectively discharge its mandates. Further, the limited resources and high turnover of experience staff undermines FI’s capacity to supervise effectively securities firms and investment fund managers. Risk-based supervision helps but all firms should be subject to a minimum level of supervision.

35. The process of representation prior to the imposition of a major sanction such as license revocation should be enhanced. FI should consider whether enforcement should be fully integrated or separated from the respective supervision teams. Furthermore, the lack of a provision whereby a licensee can make direct representations to the Board prior to it deciding to revoke a license is a major concern.

36. The balance of power is still too much in favor of securities exchanges and not the FI. The arrival of new exchanges in Sweden, within a legislative framework in which commercially driven exchanges are primarily responsible for regulating the conduct of issuers which list thereon raises the prospect of a regulatory “race to the bottom.” The government should keep the situation under review and, in due course, consider transferring full responsibility for issuer regulation to FI.

D. Payment Systems and Other Market Infrastructure

37. The RB’s new real time gross settlement system (“RIX”) complies with international standards, while the assessment of NOMX DM reveals some shortcomings. In particular, there are some legal uncertainties regarding the treatment of funds transfer and collateral transactions within RIX. Further, it is crucial to ring-fence the operation of NOMX DM in a distinct legal entity, set up a default fund financed by participants, enhance governance structure through members’ representation, introduce a new mechanism for margin collection, and diversify the source of liquidity, including access to central bank money. Both the RB and FI are empowered to carry out oversight and supervisory activities effectively. However, the RB is not empowered to issue regulations on private sector payment systems. Further, the cooperation between the RB and FI, which is guided by a high-level MOU, should be further specified so as to clarify of the division of role and responsibilities.

E. Anti-Money Laundering and Combating the Financing of Terrorism

38. In its October 2010 Follow-Up Report to its 2006 Mutual Evaluation Report, FATF recognized that Sweden has made significant progress in addressing deficiencies previously identified and decided that the country should be removed from the regular follow-up process. The mutual evaluation report had indicated that the Swedish legal requirements in place to combat money laundering and terrorist financing were generally comprehensive, but highlighted a number of areas that could be enhanced.13 Sweden’s AML/CFT system has since been considerably strengthened,14 including through legislative changes to bolster preventive measures for financial institutions, notably in the areas of customer due diligence, the implementation of a more developed legal and regulatory framework and the enhancement of the scope and effectiveness of financial institutions’ supervision. However, two shortcomings remain namely in relation to the standards for the criminalization of terrorism financing to enable the freezing of all funds, and the collection and availability of beneficial ownership information on legal persons.

V. Cross-Border Supervision and Cooperation

39. The framework for cross-border cooperation in Sweden is developing within the context of the EU-wide arrangements but has in many ways been a good model for other countries. Given the significant outward cross-border activities of the Swedish major banks, Sweden has responded actively to the challenges of its position. In particular, FI was one of the earliest jurisdictions to start putting colleges of supervisors into place, well ahead of the requirements set out in EU law and guidelines. The colleges are viewed as an active participatory process in order to achieve a shared risk assessment of a group. FI chairs supervisory colleges for the four major Swedish banks, which are fully operational, and bank-specific MOUs on supervisory cooperation have been signed. In 2008, RB signed swap agreements with the central banks of Iceland and Latvia, and in 2009 with the central bank of Estonia, to support crisis management in these countries. Further, authorities from Baltic and Nordic countries were engaged in a stress testing exercise and discussed jointly the necessary follow-up while exchange of supervisory data with Baltic counterparts intensified. The recently completed joint supervisory review process and Pillar 2 capital allocation discussion among supervisors is an important initiative in developing a shared understanding of the risk profile and activities of the large cross-border banking groups and for contingency planning.

40. Certain elements of the cross-border framework remain to be fully developed. In particular; (a) the burden-sharing principles of the 2010 Nordic-Baltic MOU need to be complemented with a more structured assessment framework, templates, and a confidential data warehouse, (b) a platform for information exchange, implied by the bank-specific MOUs, should be developed, (c) FI’s resources could be augmented to support the college work, given its resource-intensive nature, and (d) further work might be needed on modalities for addressing potential cross-border liquidity problems.

VI. Systemic Liquidity15

41. The authorities managed well the pressures on systemic liquidity and ongoing efforts to strengthen liquidity regulations are welcome. In December 2010, the FI adopted a new regulation on the governance of banks’ liquidity risk management, which embeds the main elements of the Basel principles for liquidity management. It is also planning to introduce a new comprehensive liquidity reporting framework in mid-2011, which includes quantitative liquidity risk measures, as envisaged in the Basel proposal.

42. However, the institutional and governance arrangement on international reserve management could be clarified. Although The RB’s U.S. dollar lending facility has been effective in easing funding pressures in markets, the legal framework does not clarify how potentially different views on the international reserve management policy between the RB and the SNDO could be resolved. A formal process, in the context of the proposed SFSC once established, should be set up to enable the RB to raise international reserves if deemed necessary in order to mitigate a buildup of systemic foreign exchange liquidity risks.

43. Moreover, some aspects of the domestic liquidity operational framework could usefully be reviewed. The RB changed the collateral framework as part of crisis liquidity measures and is still accepting a broader range of assets as collateral for the RB’s liquidity operations. A comprehensive review of the collateral framework is appropriately underway, aimed at toughening eligibility criteria, while maintaining a reasonable size of collateral pools and ensuring a level playing field. Furthermore, the RB’s liquidity enhancement toolkit to deal with market stress could be expanded to include, for example, a treasury securities lending facility in collaboration with the SNDO.

44. The design of ELA framework is sound but greater clarity would be helpful. The RB would provide ELA, at its discretion, only to a solvent and viable institution with liquidity problems, 16 while the SNDO is expected to deal with insolvent institutions as a resolution authority under the Support Act. Given that solvency determination can be subject to considerable uncertainty in a rapidly evolving crisis, the legal framework should clarify which authority is responsible for liquidity assistance in the different phases of events.

VII. Crisis Management and Bank Resolution17

45. Bank failures during the recent crisis have been handled relatively effectively and the authorities have demonstrated an ability to act in a coordinated and decisive manner. Nevertheless, the crisis revealed shortcomings in the framework for dealing with failing credit institutions, including the lack of specific rules on bank insolvency. This gap is particularly acute for nonsystemic institutions. A failure of even a nonsystemic institution may adversely affect market confidence and trigger broader contagion risks.

46. The authorities have launched a comprehensive review of the regulatory framework for crisis management. A committee was set up to analyze the lessons learned from the recent financial crisis and propose legislative and institutional measures to improve the authorities’ crisis management ability. The authorities are also actively involved in the EU-wide review of the crisis management framework as well as in the work of multilateral standard setting bodies.

47. The FI has a broad range of corrective and remedial powers to deal with a weak bank even though legal certainty is an issue. The FI has powers to restrict the activities and limit the operation of credit institutions, issue warnings or revoke license, replace a managing director or any member of the Board, and may order an owner with a qualified holding to divest shares. Though there are no formal triggers for early intervention powers and to require prompt corrective action, FI is able to exert supervisory pressure at an early stage. However, as noted above, FI’s powers of sanction and decision making can be affected by an appellate procedure that can suspend the execution of an administrative decision, creating legal uncertainty that has important consequences for bank resolution.

48. The framework for official financial support to systemically important financial institutions (SIFIs) introduced in 2008 is a pragmatic response to the oligopolistic structure of the banking sector (Box 2). The possibility of government support is envisaged for both continued operation of a systemic credit institution and to support its orderly restructuring or liquidation if it is no longer deemed viable. A Stability Fund, established in 2008, is financed by levies on financial institutions, and will in time provide necessary financial backing reducing direct claims on public funds, while moral hazard is mitigated by valuation rules that exclude account for the state aid.18 Approaches that would enable the authorities to write down the claims of some or all of the unsecured creditors and to convert debt into equity would usefully complement this framework taking into account work done by the Basel Committee on Banking Supervision and the Financial Stability Board (FSB).

49. The SIFI resolution framework should be complemented by a framework for orderly resolution of nonsystemic financial institutions. General company rules on bankruptcy and liquidation apply to banks and are inadequate for effectively handling bank resolution, while license revocation enforcement could be postponed by shareholders’ appeals in multiple courts and a possibility of having action stayed. Furthermore, the insolvency test, defined as inability to pay debts as they fall due, is inappropriate for banks. The mission has urged authorities to introduce a special bank resolution framework for all credit institutions, whether or not ex ante they are considered systemic. The FI should be given powers to initiate special bank resolutions administratively based upon the regulatory criteria and at a sufficiently early stage with an aim to ensure continuity of critical functions, minimize public financial support, reduce legal uncertainty and achieve a prompt resolution. The framework should give FI the right to petition for bank insolvency, transfer of assets to third-party acquirers with assumption of liabilities (purchase and assumption) should be enabled by law and the DI fund should be authorized to support purchase and assumption transactions as is already a case in a number of European countries. Finally, while preserving the rights of shareholders to appeal the FI’s decision to revoke the license, the possibility that a court stays license revocation should be removed and the shareholders should instead be entitled to monetary damages ex post.

50. The deposit insurance (DI) should be reformed to ensure its greater effectiveness as the first step of creating a holistic resolution framework. The payout by deposit insurance fund—which is ex ante funded and enjoys an unlimited loan backup from the SNDO—is triggered only after the institution has been placed into bankruptcy. The authorities are encouraged to make changes to the DI framework along the lines of the recent government proposal to bring it in line with the applicable EU requirements while work on a more comprehensive resolution framework continues.19

Government Support to Credit Institutions Act

In October 2008, the Government Support to Credit Institutions Act (2008:814, “Support Act”) was enacted as a framework to deal with weak or insolvent systemically important institutions alongside a package of other measures aimed at increasing confidence and stability of the financial sector.

Objective: Government support can be given to financial institutions headquartered in Sweden to counter a risk of severe turbulence in the Swedish financial system.

Tools: Guarantees, capital injection, and state takeover are specifically covered in the act. However, the act is broad enough to allow a response targeted to specific crisis situations as it allows also for a support in “other manner” as needed. Specific tools are detailed in government ordinances, including rules on fees paid by credit institutions for support and restrictions on remuneration during the support period.

Contractual basis: Support should as a rule be based on a contract between the bank and the state, but measures can be taken also in other cases if it is not possible or suitable to use a contract.

Support Authority: The act stipulates that a support authority is responsible for handling support measures, including orderly resolution. The Government has given this role to SNDO, while retaining the right to take final decisions on proposals for support measures put forward by the SNDO.

Appeal: In the instance the Support Authority (SNDO) and the institution fail to reach an agreement on the terms for the support, the SNDO can request that the terms be considered by a special Appeals.

Board (“Prövningsnämnden”). The Appeals Board can also rule on disagreements between the SNDO and a bank on the interpretation or application of a support contract. No case has yet been decided by the Board.

Nationalization: The SNDO has the right to nationalize an institution if it is of extraordinary importance from the public perspective that the state takes control and (i) the institution has a capital ratio below 2 percent (i.e., ¼ of the legal requirement); or (ii) refuses to reach an agreement on support on conditions found reasonable by the Appeals Board; or (iii) if the institution does not follow its obligations following from the support agreement. This decision gives rise to a right to buy out also warrants and convertibles issued by the company. Valuation of the shares must be undertaken as though the company had not received state aid. Disagreements about the right to take over an institution or about the valuation are tried by the Appeals Board.

Stability Fund: The law created a Stability Fund to be used to fund future support measures associated with administrative costs and functioning of the Appeals Board. Recoveries, fees and other incomes from support measures go to the fund. Credit institutions are required to pay a special stability fee amounting to 0.036 percent of the balance sheet total excluding equity capital and subordinated debt. Payments are placed in an interest-bearing account at the SNDO. The target for the fund is 2.5 percent of GDP within 15 years and can be used for various forms of aid. If the funds fall short of the required support, an automatic unlimited backing by the SNDO is ensured. The authorities envisage exploring a proposal to merge the stability and deposit insurance funds in the future and introduce risk-based fees. In this context, developments at the EU level will also be taken into account.

Table 7.

Sweden: Funding Cost and Other Earnings Assumptions

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Notes: The assumptions were based on historical experience and expert judgment.Source: Riksbank.
Table 8.

Sweden: Counterparty Risk Stress Test Results

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Notes: The stress test evaluates the impact of the default of the banks’ largest three exposures.
Figure 6.
Figure 6.

Sweden: Structural Liquidity Stress Test Results

Citation: IMF Staff Country Reports 2011, 172; 10.5089/9781462300198.002.A001

Notes: The figure shows a ratio similar to the Net Stable Funding Ratio (NSFR) proposed by Basel III, relating the weighted average of liabilities to the weighted average of assets. The weights are based on the stability of funding and liquidity of assets. The market was assumed to undergo a one-year stress in this case.Source: Riksbank.

Annex—Observance of Financial Supervision Standards and Codes— Summary Assessments

This Annex contains the summary assessments of standards and codes in the financial sector. The assessment has helped to identify the extent to which the supervisory and regulatory framework is adequate to address the potential risks and vulnerabilities in the financial system.

The following detailed assessments were undertaken:

  • Basel Core Principles for Effective Banking Supervision—by Keith Bell (consultant) and Katharine Seal (IMF/MCM).

  • The IAIS Insurance Core Principles—by Shu Hoong Chang (consultant).

  • The IOSCO Principles and Objectives of Securities Regulation—Richard Britton (consultant)

  • The CPSS Core Principles for Systemically Important Payment Systems—Tom Kokkola (European Central Bank)

  • CPSS-IOSCO Recommendations for Central Counterparties—Philippe Troussard (Banque de France)

Sweden’s compliance with the international supervisory standards is generally high, and many of the issues raised in the 2002 assessment have not been addressed.

A. Basel Core Principles for Effective Banking Supervision
Summary, key findings, and recommendations

1. The banking supervisory framework and its implementation in Sweden are in line with many of the Basel Core Principles’ essential criteria. Since the advent of the global financial crisis, FI has instituted a more robust supervisory approach, which has made important advances on the previous regime and initiated a number of fruitful projects but which needs continued technical development. Nonetheless, FI’s overall capacity to supervise banks, despite a consistent risk-based approach, is chiefly impacted by an acute staffing shortage. FI is established as a government authority responsible to the MOF. In practice, the assessors found evidence of impairment of FI’s operational independence through the mechanism of the annual appropriations letter process. FI’s ability to discharge its supervisory and oversight functions adequately and effectively is significantly impaired by the coupling of inadequacy of independence and resource. It is suggested that staffing levels at FI are an urgent concern to be remedied as soon as possible and also that a revised legal structure ensuring greater independence of FI be considered.

Information and methodology used for assessment

2. This assessment of the current state of the Swedish implementation of the Basel Core Principles for Effective Banking Supervision (BCP) has been completed as part of a Financial Sector Assessment Program (FSAP) Update undertaken by the International Monetary Fund (IMF) in March 2011, and reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. An assessment of the effectiveness of banking supervision requires a review of the legal framework, both generally and as specifically related to the financial sector, and detailed examination of the policies and practices of the institutions responsible for supervision.

3. The Swedish authorities agreed to be assessed according to the Core Principles (CP) Methodology issued by the Basel Committee on Banking Supervision (Basel Committee) in October 2006. The current assessment was thus performed according to a revised content and methodological basis as compared with the previous BCP assessment in 2002. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met.

4. To assess compliance, the BCP Methodology proposes a set of essential and additional assessment criteria for each principle. The essential criteria (EC) are the only elements on which to gauge full compliance with a core principle. The additional criteria are suggested best practices against which the Swedish authorities have agreed to be assessed. Additional criteria are commented on but are not reflected in the grading. The assessment of compliance with each principle is made on a qualitative basis. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. This is explained below in the detailed assessment section.

5. The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with officials of FI, and additional meetings with the Riksbank (RB), the MOF and banking sector participants. The team met the industry association representing banks in addition to a number of domestic and nondomestic institutions.

6. The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided excellent cooperation, including extensive provision of documentation, at a time when many other initiatives related to domestic, European and global regulatory initiatives are in progress.

7. The standards were evaluated in the context of the Swedish financial system’s sophistication and complexity. It is important to note that Sweden has been assessed against the BCP as revised in 2006. This is significant for two reasons: (i) the revised BCP have a heightened focus on risk management and its practice by supervised institutions and its assessment by the supervisory authority; and (ii) the standards are evaluated in the context of a financial system’s sophistication and complexity.

8. An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team. Banking systems differ from one country to another, as do their domestic circumstances. Furthermore, banking activities are undergoing rapid change after the crisis, prompting the evolution of thinking on and practices for supervision. Nevertheless, by adhering to a common, agreed methodology, the assessment should provide the Swedish authorities with an internationally consistent measure of the quality of its banking supervision in relation to the revised Core Principles, which are internationally acknowledged as minimum standards.

9. To determine the observation of each principle, the assessment has made use of five categories: compliant; largely compliant, materially noncompliant, noncompliant, and non-applicable. An assessment of “compliant” is given when all essential criteria are met without any significant deficiencies, including instances where the principle has been achieved by other means. A “largely compliant” assessment is given when there are only minor shortcomings, which do not raise serious concerns about the authority’s ability to achieve the objective of the principle and there is clear intent to achieve full compliance with the principle within a prescribed period of time. A principle is considered to be “materially noncompliant” in case of severe shortcomings, despite the existence of formal rules and procedures and there is evidence that supervision has clearly not been effective, the practical implementation is weak or that the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance. A principle is assessed “noncompliant” if it is not substantially implemented, several essential criteria are not complied with, or supervision is manifestly ineffective. Finally, a category of “nonapplicable” is reserved (though not used) for those cases that the criteria would not relate to the Swedish authorities.

10. For completeness’ sake, it should be noted that the ratings assigned during this assessment are not necessarily directly comparable to the ones assigned in terms of an FSAP performed using the pre-2006 BCP Methodology. Differences may stem from the fact that the bar to measure the effectiveness of a supervisory framework was raised by the 2006 update of the BCP Methodology, as well as by lessons drawn from the financial crisis that may have a bearing on supervisory practices.

Institutional and macroeconomic setting and market structure—overview20

11. The Swedish financial sector is large relative to GDP and the banking sector is highly concentrated. The financial system’s assets account for 550 percent of GDP, of which 65 percent belong to four systemic banking groups. There are over a hundred regulated banking entities in the nonsystemic sector, but taken in aggregate the secondary banking sector represents at least 25 percent of the domestic system (FI estimate).

12. The structure of household savings in Sweden has implications for banks’ ability to meet the forthcoming Basel standards on liquidity. Trusts and pensions have developed into significant vehicles for household savings, reflecting a relatively lower level of domestic deposits in the Swedish banking system. This feature of the banking market, coupled with a low level of sovereign debt issuance, means that banks may face higher challenges than in other jurisdictions in meeting the recently agreed Basel III liquidity framework which places emphasis on the presence of a stable retail deposit base and on stocks of high quality liquid assets, ideally government debt instruments. FI is monitoring the situation closely. It has intensified supervision of liquidity risk management, revised liquidity risk management standards (based on Basel and EU available guidelines), is in the process of trialing revised liquidity reporting requirements and undertaking a major review of liquidity practices across a broad segment of the banking market. Basel has now signaled that it recognizes that changes may be needed to its liquidity framework, but FI needs to remain alert to potential need to encourage structural changes to banks’ balance sheets.

13. The capitalization of the Swedish banking sector is strong following the crisis. The four major banks are well capitalized with a capital adequacy ratio (CAR) of 12.2 percent in part due to major rights issues in 2008 and 2009. Banks’ profits rebounded from 2009 lows and retained earnings continue to support banks’ capitalization. Profits declined in banks with Baltics exposures due to substantial increases in loan loss provisions. Most provisions were booked in 2009 and further reversals are expected owing to improved macro conditions in the Baltics.

14. All the large banks have operations within the life insurance sector, whilst many of the large insurance companies have banks of their own. Some of the banking and insurance groups exhibit a complex structure. As an integrated regulator FI is responsible for banking and insurance supervision. These supervisory functions are organized into sector specific divisions. The advantage of FI’s chosen structure is the capacity to ensure a focus on the banking and insurance risks in the respective divisions. The challenge that FI must manage is to ensure that there is sufficient management resource available to assess the interaction of banking and insurance risks within the same financial conglomerate and to avoid silo thinking.

15. Sweden is a regional banking hub. Its significance rests more in its role as a home than as a host jurisdiction but as fewer than half of the consolidated assets of the systemic groups are located in Sweden it has a critical role to play in ensuring the financial stability of the region. Sweden has responded actively to the challenges of its position. FI was one of the earliest jurisdictions to establish colleges of supervisors, well ahead of requirements in EU law and guidelines. Sweden has also been a path breaker in agreeing a multilateral memorandum of understanding (MOU) on cross border financial stability, crisis management and resolution with its peers in the Nordic/Baltic region. Work is at early stages of making concrete proposals across a range of issues, from identification of systemically important groups to resolution, monitoring and burden sharing. In the narrower field of supervisory colleges, FI’s experience in college matters makes it well placed to harness the colleges to develop a broader and deeper understanding of the banking groups’ risk profile. FI, notably, sees colleges as an active participatory process in order to achieve a shared risk assessment not merely information exchange. The success of college arrangements is work in progress for all supervisory authorities, but Sweden is particularly well placed in this respect.

16. Initiatives both at the Basel Committee and European level have influenced and contributed to the enhancement of the way FI conducts its supervision. Basel II, including Pillar II, has been implemented in Sweden through the Capital Requirements Directive (CRD) and FI has used this framework as a basis to critically assess both the systemic banking groups and the nonsystemic institutions.

17. Historically the Swedish model has been to rely on a collegiate, consensual approach to many of its supervisory interactions. There has been a high degree of trust that institutions will rectify matters as and when deficiencies are pointed out to them, which has not always been the outcome in practice. FI is currently tackling the transition challenge of moving to a more assertive approach, more disciplined and formal in follow up, while retaining a mature and constructive dialogue with the supervised entities.

Preconditions for effective banking supervision
Sound and sustainable macroeconomic policies

18. The Swedish economy enjoyed an extended period of strong growth between 2002–2008, before being affected by the global financial crisis. The economy exited from recession in mid-2009 and the severely affected financial and industrial sectors have recovered. Unlike in other countries, housing prices were resilient in the downturn. Macroeconomic developments have been favorable, but macro financial risks remain, including the degree of reliance on wholesale funding within the banking sector. GDP growth rebounded strongly and is projected to grow 2.5–3 percent in 2011–2012. Public finances are among the strongest in advanced economies, with the fiscal balance projected to return to a surplus by 2012. The financial system has been stabilized, showing increases in banks’ capital positions and lower loan losses. Improved market conditions have enabled the authorities to begin to exit from crisis response measures since April 2010.

A well-developed public infrastructure

19. Overall, the public infrastructure supporting effective banking supervision is well developed in Sweden. New cooperation arrangements were established in the financial crisis between the domestic authorities—ministry of finance (MOF), RB, FI, and the Swedish National Debt Office (SNDO)—to support financial stability. The experience of cooperation and information exchange in the crisis was positive although some gateways for exchange of information (e.g., with the SNDO) are yet to be fully opened and greater formalization of concrete cooperation practices outside of crisis periods.

20. The Swedish legal system is based on civil law. The Swedish constitution establishes the independence of the courts. The general courts deal with criminal and civil actions while the general administrative courts are responsible for cases concerning public administration, including proceedings concerning financial regulation and regulation. State Aid to financial institutions is taken before a special Appeals Board specifically established for that purpose. As a member of the EU, much domestic legislation, including banking regulation, derives from EU regulations, directives and decisions which are frequently updated to keep pace with international standards.

21. The principle of transparency is fundamental to Sweden. In principle all information that is collected by or communicated from a public Swedish authority is open for everyone to see. If, for some reason, the information shall not be disclosed, an explicit decision has to be made, stating on what legal ground the “default option”, (i.e., openness, should not prevail in that specific case. The Public Access to Information and Secrecy Act of 2009, to which FI is subject, governs disclosure and confidentiality provisions.

22. Sweden has implemented IFRS. There is a full range of high-quality accountancy, audit, legal, and ancillary financial services available in the jurisdiction.

Effective market discipline

23. The principle of disclosure and transparency is well established in the Swedish context. In addition, with respect to the banking and financial sector, transparency is supported by the application of the “Pillar 3” disclosure framework of the Basel Capital Accord, which has been implemented in Sweden through the relevant EU legislation (CRD). The public statement on FI’s website states that it discloses as much information as possible in order to give the public insight into what is happening on the financial market, but that it does not, however, disclose sensitive information that can affect a firm’s competitive positioning on the market. FI also issues, on a regular basis, reports assessing and describing the risk environment. The RB publishes a biannual financial stability report.

Financial sector safety net

24. Deposit insurance was introduced in Sweden in 1996 in conformity with the EU directive on deposit guarantee schemes. Since the end of 2010, deposits in credit institutions are protected to the maximum limit of €100, 000. Since the introduction of the scheme there have been few failures in Swedish institutions leading to a payout, two in 2006 when the scheme was administered by the now disbanded Deposit Guarantee Board and one in 2010. The scheme has been managed by the SNDO since 2008. Currently, payout under the deposit insurance scheme is triggered only when the institution is placed into bankruptcy. Although the FI can revoke a license, it cannot place an insolvent institution into bankruptcy. The deposit protection scheme plays no role in bank restructuring and is funded ex ante according to a fee structure that is sensitive to the capital adequacy strength of the individual institutions making the contribution. Deposits made to deposit companies pursuant to the Deposits Business Act are not covered by the deposit protection scheme. The deposits that can be made to such companies are limited to SEK50, 000 per individual.

25. Crisis measures to protect the stability of the banking system were largely based on the 2008 Government Support to Credit Institutions Act. Specific measures included debt guarantee, recapitalization, and bank takeover. As a state-aid measure the Act and the programs based on it were subject to scrutiny by the European Commission. In April 2010 the authorities began to exit from crisis-response measures. Banks participating in the support schemes were subject to restrictions on remuneration to senior management. Additionally, the RB implemented a sweep of new liquidity measures through expanding its balance sheet, and took a number of measures to support banks’ capital and assure markets. At the same time, the SNDO borrowed externally to boost international reserves, and the RB established swap facilities with the U.S. Federal Reserve and ECB.

Main findings