Swedish banks start adding risk weights to government bonds

 18 Jul 2017 - 1:19

Swedish banks start adding risk weights to government bonds

By Hanna Hoikkala and Frances Schwartzkopff / Bloomberg

It was the elephant in the room throughout Europe’s debt crisis, but ultimately too sensitive an issue for supervisors to fiddle with.

Regulations have historically implied that government bonds are risk-free. But Greece’s near-death experience quickly made a mockery of that assertion. Now, Sweden is taking the next step and banks in the country are starting to assign risk weights bigger than zero to the government bonds on their balance sheets.

SEB AB, the first of Sweden’s big banks to report second-quarter results, said on Friday it added 9 billion kronor ($1.1 billion) to its risk-weighted assets in the first half of the year, to reflect the fact that there’s a greater-than-zero chance it may suffer losses on its holding of sovereign debt.

The move follows a decision by the Swedish Financial Supervisory Authority to stop the country’s four largest banks using so-called standardized approaches that have allowed them to assign zero risk-weights to government debt. Instead, banks are required to use internal risk-based models for the asset class.

Nordea Bank AB is in the process of applying its new IRB model. The bank said in April the FSA approved the approach, with “full technical implementation” due in the second quarter.

Excessive Debt

For Swedish banks, the extra cost is likely to be negligible because holdings of government bonds are mostly limited to those issued in the Nordic region. SEB’s chief executive officer, Johan Torgeby, says the requirement is “not a meaningful change for the bank.”

Elsewhere in Europe, banks remain free to assign zero risk weights to sovereign bonds as some governments continue to grapple with excessive debt levels.

The European Commission is slated to come up with a new plan for how to handle banks’ sovereign debt holdings, but as of June no timeline had been set. It’s a “politically and economically complex issue” that could destabilize financial systems if not handled correctly, according to a May EC paper on the economic and monetary union.

Even the other Scandinavian regulators say they’re unlikely to follow Sweden’s example.

“We acknowledge that the risk weights for sovereign exposures under the standardized approach may not always be reflective of the actual risk,” Jesper Berg, the head of the Danish FSA, said in an emailed response to questions. He says the Danish regulator doesn’t see “any urgent need to address this,” because banks in the country “are not heavily exposed to sovereigns outside the Nordic region.”

Skinning a Cat

If risks were to rise, Denmark would be “more likely to address it by other measures than requiring banks to develop risk models,” Berg said. “We would normally use Pillar 2 add-ons to address risks that are not properly reflected in Pillar 1,” he said. “There are many ways to skin a cat.”

Norway also lets its banks apply zero risk weights to government bonds. “This is due to inherent challenges in estimating probabilities of default and loss-given-default levels in these low default portfolios,” Bjorn Andersen, a departmental head at the Norwegian regulator, said in an emailed reply to questions.

Torgeby, the SEB CEO, said Swedish banks operate in “a very conservative part of the world.”

“But it would be nice to have a level playing field in Europe,” he said.