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IMF Country Report No. 23/113

SWEDEN

FINANCIAL SYSTEM STABILITY ASSESSMENT

March 2023

This paper on Sweden was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on February 10, 2023.

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SWEDEN

FINANCIAL SYSTEM STABILITY ASSESSMENT

February 10, 2023

KEY ISSUES

Context: Sweden recovered rapidly from the Covid1-19 crisis, and GDP reached its pre-pandemic level in mid-2021. In the context of a robust supervision and regulation framework, the financial sector exited the crisis with substantial capital and liquidity buffers. Going forward, growth is expected to slow amid higher energy prices, tighter financial conditions, and reduced confidence following sharply lower house prices. Given stubborn inflation, the Riksbank has been normalizing rates more aggressively than expected last year. Systemic risks to the financial system arise from (i) high exposure of banks to the commercial real estate (CRE) sector; (ii) limited liquidity in corporate bond markets; (iii) high indebtedness of households and sensitivity to higher interest rates. The banking system is nearly three times 2021 GDP and is interconnected domestically and regionally.

Findings: Stress tests indicate that banks are broadly resilient to simulated shocks as their capital should remain above minimum requirements. However, some scenarios, including losses due to an increase in CRE exposures, cut into capital buffers, and amplification effects (such as dislocations in corporate debt markets) could lead to starker outcomes. Banks have sufficient liquidity buffers, but some investment funds are exposed to illiquid corporate securities. The frequency and intrusiveness of onsite supervisory inspections is insufficient, and AML/CFT oversight has been weak. The fintech sector is growing rapidly in size and relevance, raising risks that some firms evade the regulatory perimeter. The introduction of CBDC could lead to structural changes in the banking sector, and potentially lower profits. The rapid digitalization of the Swedish payment system raises risks of cyber-attacks and of supervision falling behind.

Policy advice: Authorities should consider higher capital requirements for banks given CRE and residential real estate risks. They should also address resource constraints to strengthen supervision of banks and fintech firms. The macroprudential policy toolkit should be expanded and institutions should better coordinate. The materiality of CBDC risks on the financial system should be further evaluated. Authorities need to enhance operational capacity and internal practices for crisis management and remove remaining barriers to resolvability. AML/CFT supervision should leverage new data tools. Authorities also need to enhance supervisory and oversight regimes for critical payment system providers. Finally, a comprehensive cyber resilience supervisory framework is needed.

Approved By

May Khamis and Oya Celasun

Prepared By

Monetary and Capital Markets Department

• The FSAP team was led by Tommaso Mancini-Griffoli and included Mindaugas Leika (Deputy Mission Chief), Leonard Chumo, Agnija Jekabsone, Elisa Letizia, Marcello Miccoli, and Etienne Yehoue (MCM); Svetlana Vtyurina (EUR), Steve Dawe (LEG); Fabiana Amaral, Rhiannon Sowerbutts, Nick Strange, Massimo Ferrari, and Eamonn White (experts). Carlos Chavez (MCM) provided research assistance, and Erica Sandoval (MCM) provided administrative support. The mission met the Riksbank Governor, Mr. Stefan Ingves; the Minister for Financial Markets, Mr. Max Elger; the Director General of Finansinspektionen, Mr. Erik Thedéen; and the Director General of the National Debt Office, Ms. Karolina Ekholm. The mission also met industry associations, banks, fund managers, fintech companies, academics, and market analysts. The team would like to thank all counterparts for their hospitality, cooperation, and fruitful discussions.

• FSAPs assess the stability of the financial system as a whole and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• Sweden is deemed by the Fund to have a systemically important financial sector according to SM/10/235 (9/16/2010), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the Fund’s Articles of Agreement.

• This report was prepared by Tommaso Mancini-Griffoli, Mindaugas Leika, and the mission team.

Contents

• Glossary

• EXECUTIVE SUMMARY

• MACROFINANCIAL SETTING

• A. Macrofinancial Developments

• B. Structure and Performance of the Financial Sector

• SYSTEMIC RISK ASSESSMENT

• A. What are the Key Macro-Financial Risks?

• B. Macrofinancial Risk Scenarios

• C. How Resilient is the Financial System?

• D. What Are the Financial Stability Implications of Interconnectedness?

• E. Are There Systemic Risk Issues from an Introduction of the E-Krona?

• F. Is the Fintech Sector Creating Systemic Risk?

• FINANCIAL SECTOR OVERSIGHT

• A. How Effective is Microprudential Supervision in Addressing Risks?

• B. How Effective is Macroprudential Policy in Mitigating Systemic Risks?

• C. How Well is Cyber Risk Being Incorporated in Financial Oversight?

• D. How Safe are Financial Market Infrastructures?

• E. How to Further Improve the Financial Integrity Framework?

• F. How to Adopt to Supervision and Regulation of Climate-Related Risks?

• CRISIS MANAGEMENT, RESOLUTION, AND SAFETY NETS

• AUTHORITIES’ VIEWS

• BOX

• 1. RWAs Density

• FIGURES

• 1. Selected Economic Indicators

• 2. Structure of Financial Sector

• 3. Selected Banking Indicators

• 4. Selected Corporate Debt Indicators

• 5. Selected CRE Financial Ratios

• 6. Stress Test Macroeconomic Scenarios for Sweden

• 7. CRE Stress Test Results

• 8. Results of Scenario-Based Solvency Stress Test and Sensitivity Test

• 9. Results of Liquidity Stress Test

• 10. Investment Funds Stress Test

• 11. Interconnectedness

• 12. Developments in the Fintech Sector

• 13. Contagion in the CRE Market

• 14. Agencies and Authorities with an Interest in Cyber Security

• 15. FMI Landscape in Sweden

• 16. Timeline of Climate Risk Related Measures Adopted by FI

• TABLE

• 1. 2022 FSAP Key Recommendations

• APPENDICES

• I. Selected Economic Indicators

• II. Financial Soundness Indicators

• III. Implementation of 2016 FSAP Recommendations

• IV. Risk Assessment Matrix

• V. Stress Testing Matrix

• VI. Liquidity Stress Testing Scenarios

Glossary

Executive Summary

The Swedish Financial sector weathered the global COVID-19 crisis well, to a large extent due to significant capital and liquidity buffers, the Riksbank’s interventions in bond markets, as well as public support for the real and financial sectors. Swedish banks entered the COVID-19 crisis with substantial capital and liquidity buffers, thus allowing them to continue providing credit to the real sector. The economy recovered rapidly in 2021 as the Riksbank stepped in to support diminishing liquidity in markets and the government had ample fiscal space to support struggling companies. Growth is expected to slow down due to higher energy prices, tighter financial conditions, higher geopolitical uncertainty due to the war in Ukraine, as well as supply side constraints and lower property prices.

The cyclical risks to financial stability emerge from a potential turn in the credit cycle, lower real estate prices, higher funding costs, and illiquid markets for corporate debt. The Riksbank brought forward the path of monetary policy tightening, raising the policy rates and starting a reduction of its balance sheet. Higher policy rates in Sweden and in other advanced economies, while necessary to tackle inflation, are increasing debt servicing costs for households and especially highly leveraged corporates. This could further weigh on consumption and investment, demand for credit, and ultimately real estate prices.

Growing structural vulnerabilities—such as historically high household and CRE sector indebtedness—amplify cyclical risks to financial stability. Household debt is at its historic peak and a large fraction is at variable rates,¹ thus sensitive to higher interest rates, which have risen significantly since the FSAP mission. Further hikes are possible, as are further declines in housing prices. The latter should not induce a spike in household defaults, as loans have full recourse and there are generous social benefits, such as unemployment insurance. However, debt servicing costs have risen and could rise further. While households can withstand a large shock to interest rates, consumption will get squeezed, further reducing growth and straining the corporate sector, which is also highly leveraged with debt securities accounting for nearly half of its funding. The CRE-sector is highly indebted and concentrated, and exposed to funding rollover and interest rate risks and further declines in rental rates resulting from a structural shift to remote work, all of which could weigh on yields and cash flows.

A large and concentrated banking sector has high current and contingent exposures to CREs. The banking sector size is nearly three times 2021 GDP, twice the European median, wholesale funding accounts for a large share of its liabilities, and banks are highly interconnected with other financial institutions at both the domestic and regional levels. Yet, in the last five years, banks’ role in domestic financial markets declined slowly, as investment funds increased their size.² Banks’ exposure to the mortgage and CRE sector is high, but so too are regulatory capital ratios. While the authorities introduced risk weight floors for CRE and mortgage exposures, capital ratios are still supported by relatively low risk weight densities.

FSAP bank solvency stress tests (ST) suggest that the banking system appears resilient to simulated adverse shocks, though capital buffers decline more if CRE exposures were to grow further. Under a scenario that envisages tighter domestic and global financial conditions and fall in asset prices, the impact of shocks on capital is high. While no bank falls below the minimum capital requirements, systemwide CET1 ratio is depleted by 620 bps, especially for banks heavily exposed to the commercial CRE sector. Banks benefit from high lending margins in the adverse scenario, which partially cushions the negative impact of loan-loss provisions and market losses. However, if CRE exposures increased, for instance through credit lines being drawn down, the negative impact on bank capital would be an additional two hundred basis points.

Despite its substantial share of wholesale funding, the Swedish banking system appears resilient to large liquidity shocks. Liquidity stress tests suggest that banks can withstand large outflows of wholesale and retail funding and the closure of covered and corporate bond markets for up to 3 months. Accumulated reserves at central banks constitute the largest share of liquid assets immediately available. FX swap and derivative markets activities, as well as credit lines, require additional monitoring to better identify and quantify contingent liquidity as well as wholesale funding risks.

Most of the investment funds would be able to withstand severe but plausible redemption shocks, except those not sufficiently diversified or heavily exposed to unrated or poorly rated debt. More than 70 percent of investment funds analyzed appear to have enough highly liquid assets to meet investors’ redemptions. However, many corporate bonds are traded infrequently, thus limiting the ability to gauge the price impact of redemptions in times of stress.

Macroprudential policy can help attenuate cyclical and structural risks. Greater use of “soft powers” and joint communication by institutions comprising the Financial Stability Council (FSC) could help sway firms’ behavior. CRE firms could be encouraged to disclose their contingency funding plans in their annual reports and bond prospectuses. Collecting better data on household assets and liabilities would help calibrate macroprudential (and monetary) policy. And the financial supervisory authority, Finansinspektionen (FI), should consider higher capital requirements or buffers for banks’ exposures to CRE risks due to notable amplification and spillover channels from CRE solvency to the macro-economy.

The shift to digital means of payments, from central bank digital currency (CBDC) to outsourcing and cyber-attacks, brings new risks that need to be contained. The introduction of CBDC could lead to structural changes of the banking sector and potentially lower profits. The fintech sector is growing rapidly in size and relevance and needs to be better understood. The decision to adopt foreign payment systems and the development of a new Nordic payment system requires managing outsourcing risks. In addition, regulation and cross-border supervisory arrangements must adapt to these changes. Cyber threats have become more prominent, hitting many Swedish financial institutions. A framework for comprehensive operational and cyber resilience is needed.

Bank supervision has been effective though could be improved, in great part by increasing resources. Onsite inspections must become more frequent and intrusive. More efficient analytical tools and risk dashboards could facilitate offsite monitoring of banks and help optimize limited resources by ensuring that supervisory activities are better targeted. FI should step up AML/CFT supervision targeted to high-risk areas, such as correspondent banks, and improve risk-based supervision of Virtual Asset Service Providers (VASPs). To enhance the supervisory ML/TF risk assessment and the analysis of financial flows, more quantitative and granular data on transactions, customers, and controls should be collected. More experienced resources are needed in specialized areas such as cybersecurity and IRB models. FI should receive greater and more stable funding to enhance resources, while it should develop a strategy to better attract and retain staff.

The crisis management and resolution framework has improved since the 2016 FSAP, though would still benefit from greater clarity and guidance in multiple areas. Operational details need to be elucidated, including a watchlist to identify banks at risk of failure and a consistent methodology to determine banks’ solvency, viability, and systemic impact. To better prepare for future bank failures, banks must still remove barriers to resolvability. On managing failed banks, the National Debt Office (NDO) should stand ready to use its resolution tools to support effective crisis response involving failing systemic financial institutions. The MoF’s role in approving NDO resolution decision-making that might have “direct budgetary or systemic effect” should be limited to resolutions that require funding from government budget only. Finally, the Riksbank should publish a policy framework describing the central bank’s lender of last resort bilateral liquidity facilities, including funding in resolution.

Climate-related risks, while not presenting an immediate threat to financial stability, should be further integrated into the supervisory process. Authorities published several studies related to climate risk. While physical and transition risks are not a major source of concern for Swedish financial institutions for now, the authorities should expand their capacity to assess climate risks and encourage climate risk disclosures in the financial sector.

^{Table 1.}

Sweden: 2022 FSAP Key Recommendations

*Immediate (within 1 year), ST—Short term (within 1-2 years), MT—Medium term (within 3-5 years) **Priority for CBDC recommendations not inserted as time horizon will depend on whether the e-krona project continues.

^{Table 1.}

Sweden: 2022 FSAP Key Recommendations

	Reference	Authority	Priority
Systemic Risk Analysis
Employ structural models (household and CRE) to complement bank stress tests; develop tools to analyze contingent liquidity risks from loss of longer-term wholesale funding as well as corporate exposures for the largest banks.	20, 24, 27	FI	Immediate
Require investment funds to offer redemption terms that are aligned with the liquidity profile of their portfolio; consider price- and quantity- based measures (e.g. swing pricing and gates); and provide guidance on liquidity stress tests.	31	FI, MoF	Medium-term
Macroprudential Policies and Systemic Risk Oversight
Introduce standards on the interest rate stress-tests that banks apply for mortgage loan applicants	54	FI	Short-Term
Commission an independent study to determine the costs and benefits of the tax deductibility of mortgage interest.	54	MoF	Medium-Term
Consider higher capital requirements and/or buffers for banks’ exposures to CRE risks.	57	FI	Short-Term
FSC, FI, and the Riksbank to use soft powers and joint communication to ask CRE firms to disclose their contingency funding plans in annual reports and bond prospectuses.	56	FI and Riksbank	Short-term
Banking Supervision and Regulation
Increase resources to improve on the effectiveness of supervision and improve supervisory toolkit further by enhancing offsite monitoring and screening tools, automating the collection and analysis of supervisory data, improving internal supervisory manuals, and deploying risk dashboards covering all the key risks.	45	FI	Immediate
Enhance supervision by: (i) increasing the frequency and intrusion of onsite inspections; (ii) comprehensive onsite inspection of banks, (iii) ongoing assessment of performance of the Internal Rating Based (IRB) models and banks’ internal stress test processes, (iv) well-targeted thematic reviews for smaller institutions; and (v) heightened focus on small but high-risk institutions.	44, 46	FI	Short-term
Continue integrating climate-related risks into supervisory processes and ensure alignment of practice with emerging international standards.	67	FI	Medium-term
FI should strengthen its supervision of banks and VASPs targeted at ML/TF risks especially from cross-border operations by evolving risk management tools and collecting and analyzing more granular data.	64,65		Short-term
Cyber Resilience
Clarify roles and responsibilities for cyber security risk management; develop contingency plans and crisis protocols for large-scale attacks; enhance information sharing among agencies and with the financial sector.	59	FI, MoF, the Riksbank NCSC, MSB	Immediate
Establish and maintain a database of essential service providers and outsourcing arrangements, including to identify concentrations and dependencies.	59	FI	Immediate
Financial Market Infrastructures
Strengthen legal frameworks for weakly regulated FMIs to enforce compliance with the PFMI and other guidelines; strengthen regulation, oversight, and supervision of key service providers Getswish and Finansiell ID-Teknik BID AB.	62	MoF, FI, the Riksbank	Short-term
Crisis Management, Resolution and Safety Nets
Develop crisis management capacity within and between the authorities by formalizing a watchlist process to identify banks at risk of failure.	69	FI	Immediate
Ensure bank resolution plans are fully operational by clarifying MREL regulation and removing other known barriers to resolvability; publish the approach for deploying bail-in and transfer tools and imposing losses on MREL holders.	71	NDO & FI	Immediate
Publish a policy framework describing the lender of last resort bilateral liquidity facilities, including funding in resolution.	72	Riksbank	Immediate
CBDC and Fintech**
Extensively test the robustness and resilience of CBDC, and analyze the effectiveness of financial safeguards, and the impact on the payments and financial system.	38	Riksbank	Short-term
Facilitate exchange of information and enhance understanding of risks between Fintech firms and supervisors; collect additional data to support a more comprehensive analysis of fintech firms and conduct periodically a review of the adequacy of the regulatory perimeter.	41	FI	Medium-term

*Immediate (within 1 year), ST—Short term (within 1-2 years), MT—Medium term (within 3-5 years) **Priority for CBDC recommendations not inserted as time horizon will depend on whether the e-krona project continues.

View Table

^{Table 1.}

Sweden: 2022 FSAP Key Recommendations

	Reference	Authority	Priority
Systemic Risk Analysis
Employ structural models (household and CRE) to complement bank stress tests; develop tools to analyze contingent liquidity risks from loss of longer-term wholesale funding as well as corporate exposures for the largest banks.	20, 24, 27	FI	Immediate
Require investment funds to offer redemption terms that are aligned with the liquidity profile of their portfolio; consider price- and quantity- based measures (e.g. swing pricing and gates); and provide guidance on liquidity stress tests.	31	FI, MoF	Medium-term
Macroprudential Policies and Systemic Risk Oversight
Introduce standards on the interest rate stress-tests that banks apply for mortgage loan applicants	54	FI	Short-Term
Commission an independent study to determine the costs and benefits of the tax deductibility of mortgage interest.	54	MoF	Medium-Term
Consider higher capital requirements and/or buffers for banks’ exposures to CRE risks.	57	FI	Short-Term
FSC, FI, and the Riksbank to use soft powers and joint communication to ask CRE firms to disclose their contingency funding plans in annual reports and bond prospectuses.	56	FI and Riksbank	Short-term
Banking Supervision and Regulation
Increase resources to improve on the effectiveness of supervision and improve supervisory toolkit further by enhancing offsite monitoring and screening tools, automating the collection and analysis of supervisory data, improving internal supervisory manuals, and deploying risk dashboards covering all the key risks.	45	FI	Immediate
Enhance supervision by: (i) increasing the frequency and intrusion of onsite inspections; (ii) comprehensive onsite inspection of banks, (iii) ongoing assessment of performance of the Internal Rating Based (IRB) models and banks’ internal stress test processes, (iv) well-targeted thematic reviews for smaller institutions; and (v) heightened focus on small but high-risk institutions.	44, 46	FI	Short-term
Continue integrating climate-related risks into supervisory processes and ensure alignment of practice with emerging international standards.	67	FI	Medium-term
FI should strengthen its supervision of banks and VASPs targeted at ML/TF risks especially from cross-border operations by evolving risk management tools and collecting and analyzing more granular data.	64,65		Short-term
Cyber Resilience
Clarify roles and responsibilities for cyber security risk management; develop contingency plans and crisis protocols for large-scale attacks; enhance information sharing among agencies and with the financial sector.	59	FI, MoF, the Riksbank NCSC, MSB	Immediate
Establish and maintain a database of essential service providers and outsourcing arrangements, including to identify concentrations and dependencies.	59	FI	Immediate
Financial Market Infrastructures
Strengthen legal frameworks for weakly regulated FMIs to enforce compliance with the PFMI and other guidelines; strengthen regulation, oversight, and supervision of key service providers Getswish and Finansiell ID-Teknik BID AB.	62	MoF, FI, the Riksbank	Short-term
Crisis Management, Resolution and Safety Nets
Develop crisis management capacity within and between the authorities by formalizing a watchlist process to identify banks at risk of failure.	69	FI	Immediate
Ensure bank resolution plans are fully operational by clarifying MREL regulation and removing other known barriers to resolvability; publish the approach for deploying bail-in and transfer tools and imposing losses on MREL holders.	71	NDO & FI	Immediate
Publish a policy framework describing the lender of last resort bilateral liquidity facilities, including funding in resolution.	72	Riksbank	Immediate
CBDC and Fintech**
Extensively test the robustness and resilience of CBDC, and analyze the effectiveness of financial safeguards, and the impact on the payments and financial system.	38	Riksbank	Short-term
Facilitate exchange of information and enhance understanding of risks between Fintech firms and supervisors; collect additional data to support a more comprehensive analysis of fintech firms and conduct periodically a review of the adequacy of the regulatory perimeter.	41	FI	Medium-term

*Immediate (within 1 year), ST—Short term (within 1-2 years), MT—Medium term (within 3-5 years) **Priority for CBDC recommendations not inserted as time horizon will depend on whether the e-krona project continues.