Riksbank holds rates as IMF sees ‘sizeable' risks at Swedish banks

A split Swedish Riksbank has held its main interest rate steady in a bid to help boost economic activity and increase inflation back up to the target level, while containing high and rising household debt.

The Riksbank's executive board left the Repo rate unchanged at 1.0%, reiterating its intention to keep it there until the end of 2014. Two members, Karolina Ekholm and Martin Flodén, advocated a 25-basis point cut, and expressed a desire to keep the rate at 0.75% until the second quarter of next year, the Riksbank said.

The Riksbank statement added that the repo rate "needs to remain at the current low level until economic activity is showing a clearer improvement and inflation has risen" towards the 2% target level, which the Riksbank expects to reach in 2015.

"The monetary policy being conducted now is expected to stimulate economic developments… [while] taking into account the risks linked to households' high indebtedness," the Riksbank said.

The government's decision last week to put the country's Financial Supervisory Authority (FSA) in charge of regulating financial markets "clarifies the allocation of responsibility and gives better conditions for taking further measures to reduce risks linked to households' high indebtedness", the Riksbank said.

Sweden's minister for financial markets, Peter Norman, announced last Tuesday that the FSA would be given "overall responsibility" for supervising and regulating the country's financial institutions – singling out democratic accountability as the "overriding motive" for the new arrangement.

Earlier this summer, Stefan Ingves, governor of the central bank, argued the Riksbank had "solid fundamentals" to take on such a task, and also pointed to potential "synergies" between macro-prudential and monetary policy. At a press conference today, Ingves said it was good that matters had been resolved, but declined to comment further.

In comments published yesterday, former Riksbank executive board member Lars Svensson criticised the Riksbank's monetary policy agenda, which he argued has led to too-low inflation and unnecessarily high unemployment.

Svensson, who stepped down in April, said it had "not presented any analysis of how monetary policy and the policy rate affect household indebtedness".

"The higher rate reduces nominal housing prices and new mortgages, but since the new mortgages are such a small share of total mortgages, the total nominal debt falls very slowly. Yet nominal GDP falls much faster, so the debt-to-GDP ratio rises," Svensson argued, concluding that a higher interest rate thereby leads to a higher debt ratio, not a lower one.

IMF highlights vulnerable banks

Regulation of financial markets also loomed large in the International Monetary Fund's Article IV report on the Swedish economy, published today alongside reports on Norway and the Nordic region as a whole.

The International Monetary Fund (IMF) said downside risks "remain sizeable, especially in the banking and household sectors" in Sweden, notwithstanding ambitious efforts by the authorities to strengthen the financial system by increasing capital and liquidity buffers and introducing a loan-to-value (LTV) cap and risk weight floor for mortgages.

"Credit to households continues to expand faster than disposable income, with mortgage amortization low by international standards," the IMF noted, adding that the share of interest-only loans in Sweden is about 71% for mortgages with LTV ratios below 75% in 2012, well above that in other Nordic countries. Ingves today said the LTV mortgage cap may have caused the rate of household debt to slow.

The IMF also noted that while Swedish banks' core Tier I capital buffers are among the highest in Europe – systemically important banks all have capital ratios above 12%, five percentage points higher than the Basel III minimum – this has been driven mainly by a reduction in risk-weighted assets, as lenders are increasingly passing on corporate loans in favour of mortgages. Leverage remained largely stable.

Swedish banking assets are worth four times its GDP, making the country's banking system among the world's biggest relative to the size of the economy. About 85% of these assets are held by the four biggest banks – Nordea, SEB, Handelsbanken and Swedbank – which extend 80% of their credit to Nordic households and corporates.

With a loan-to-deposit ratio of about 200%, wholesale loans, mostly in foreign currency, account for about one third of Swedish bank funding.

The Riksbank said last week it will boost borrowed currency reserves by about one third to $55 billion, equivalent to 10% of GDP, while making the banks bear some of the brunt via a fee. Nevertheless, the IMF said, "Sweden's banking system remains vulnerable to sudden shortages of foreign currency liquidity".

It added that "given the substantial international aspect of Sweden's banking operations," supervisory and regulatory coordination could eventually benefit from membership in a European banking Union.

Bank of Finland deputy governor Pentti Hakkarainen yesterday called on Sweden and Denmark – neither of which is a eurozone member – to opt in to the forthcoming EU Single Supervisory Mechanism (SSM), insisting the Nordic region "should certainly be no exception" to a unified European regulatory structure.

Krona at 10-year high, despite low growth

The IMF lauded the Riksbank's plans to unload some of the costs of maintaining foreign currency reserves on the banks, but said it should go further by introducing reserve requirements in foreign currency at the central bank.

It also encouraged Sweden to raise banks' funding stability standards. "Establishing firm interim targets for reaching the minimum level of 100% of the Basel III NSFR by 2018 – a goal also explicitly recommended by the Riksbank – will help reduce structural liquidity risks," the fund argued.

It warned that an excessive reversal of safe-haven flows, though unlikely, may prompt a premature tightening of financial conditions, potentially exacerbating financial risk in Sweden and the other Nordic countries.

Sweden's safe-haven status caused the krona to reach a 10-year high in nominal terms earlier this year, despite a slowdown in growth to less than 1%. The current account is currently 7%.