A snapshot of Swedish actions to date in light of the

UNCLAS STOCKHOLM 000707 Treasury for DAS Eric Meyer, William Lindquist, and Vimal Atukorala E.O. 12958:N/A TAGS: EFIN PINR ECON PGOV SW SUBJECT: A snapshot of Swedish actions to date in light of the financial turmoil ¶1. Summary. The Swedish financial system remains robust, owing to conservative lending practices, very high profitability in recent years, and a strong central bank. However, in response to the global financial turmoil, the following actions have been taken: -- The National Debt office has auctioned extra treasury bills; -- The Central Bank has provided access to long-term financing in Swedish Krona; -- The Central Bank has offered large loans in U.S. dollars; -- The Central Bank has lowered its Steering rate by 50 basis points; -- The Government presented its Stability plan on October 20, building on the agreement within the EU. This cable provides background on the Swedish experiences with its 1991-1992 banking crisis, and a Bio of Central Bank Governor Stefan Ingves. A second cable will provide Ingves' prescriptions for further stabilization action, based on Ambassador's October 21 meeting. End summary. The current situation in the Swedish financial system: Manageable, low credit losses, still liquid ___________________________________________ ¶2. According to the Swedish Financial Supervisory Authority and the Central Bank the Swedish banks continue to have strong balance sheets. Their capital situation is strong, credit losses are low and profitability has reached historic highs. The Swedish banks have been relatively conservative in their lending, and have not been exposed to any great extent to the worst-hit markets or institutions. ¶3. However, the current international financial turmoil has caused several parts of the credit market to not work as well as usual. For example, due to uncertainty among investors, we have seen a sharp increase in demand for Swedish government securities and a corresponding decrease in demand for mortgage bonds. This development caused the Swedish National Debt Office to auction extra treasury bills and use the money to buy mortgage bonds. ¶4. The uncertainty has also had an impact on the interbank lending, as it has become more difficult to borrow over longer time periods, and on the international markets. Even if the major Swedish banks are lending to each other, international investors are less willing to invest, which has reduced the supply of loans and driven up the banks' cost of borrowing. Higher borrowing costs do not mean that the banks have problems (in the sense that their financial situation is threatened). It is true that the Icelandic bank Kaupthing's Swedish subsidiary did suffer from an acute liquidity need, due to developments in Iceland, and was forced to turn to the Central Bank. However, the major Swedish banks do not have - nor have they had - any of the liquidity problems that Kaupthing and banks in other countries have had. ¶5. Nevertheless, there is a significant risk that the credit supply to Swedish companies and households could worsen considerably if the problems on the credit markets take hold and persist. It is in part against the background of this risk that we should view the Central Bank's liquidity support measures over the past few weeks. It is also one of the reasons for the Central Bank's most recent decision to cut its Steering rate by 0.5 percentage points. Multiple Swedish authorities ____________________________ ¶6. The Central Bank is not the only authority that is responsible for ensuring financial stability. The Financial Supervisory Authority also plays an important regulatory role. In the current crisis, the National Debt Office has also helped to improve liquidity conditions in the financial system by auctioning extra treasury bills. Ultimately, the Government and the Riksdag also have a responsibility for financial stability if it becomes apparent that the initiatives of the authorities are unable to bring a crisis under control. Measures taken by the Central Bank __________________________________ ¶7. The purpose of the measures is to solve two problems with the Swedish banks: inadequate access to long-term financing in Swedish Krona and a limited ability to gain access to US dollars. ¶8. The lack of long-term financing is due to the lack of mutual trust among the banks during the crisis, which have had a negative impact on the interbank lending markets. One consequence is that the banks have been forced to borrow for shorter terms. Even if it has been possible to get financing, liquidity management has become much more difficult for the banks and risks also have increased. To enable the banks to restore the situation to more normal conditions, the Central Bank has offered financing at longer terms than what the markets can currently provide by lending Swedish Krona with maturities of three and six months. ¶9. The lending is designed so that the Central Bank provides liquidity in the form of somewhat longer loans and absorbs the same quantity of short term liquidity. Combined with the fact that lending takes place at market rates, this means that banks receive help with their strained financing situation at the same time that the measures do not have any direct effects on monetary policy. This is a very important point. The Central Bank is quite simply helping the banks replace their short-term financing with longer-term financing. In a broader sense, the Central Bank is assuming the role of market maker in the money market and by doing so ensuring its functioning. ¶10. The othQ problem is that a general shortage of financing opportunities in US dollars has arisen. Since the Swedish banks are not counterparties with the US central bank, they cannot be certain that they will receive any of the injections of liquidity that the Federal Reserve makes. That is why the Central Bank has offered their counterparties large loans in US dollars. ¶11. Together with the measures that the National Debt Office have taken, the Central Bank's lending of both Swedish Krona and US dollars contributes to a general strengthening of liquidity primarily in the Swedish credit markets, thereby also creating conditions for the markets to return to more normal conditions and allowing financial stability to be maintained. ¶12. The Central Bank has also provided special liquidity assistance to Kaupthing Bank Sweden (subsidiary to Icelandic Kaupthing Bank). This loan is against collateral and with an interest rate that is above normal lending costs. Even if this measure is aimed at an individual bank, it should also be viewed as an initiative to safeguard financial stability and to maintain confidence in Sweden's entire credit and payment system. The decision is based on the assessment that although the bank is solvent, it is unable to perform its obligations without liquidity assistance. What happens next with Kaupthing Sweden is mainly a question for the bank's owner, the Icelandic state. ¶13. The common denominator for everything the Central Bank has done to date is that all measures are aimed at strengthening liquidity conditions within the Swedish financial system. Unlike many other countries, thus far it has not been necessary for the Swedish authorities to provide the banks with any form of capital support from the government. This point is also important. However, it remains to be seen whether the Central Bank and other authorities have done enough. How the situation develops in the future is essentially a question of what happens outside of Sweden. Nevertheless, the Swedish authorities are prepared to take those measures that are necessary to ensure financial stability. For the Central Bank, this means that it will continue to provide the banks with the liquidity required for the financial system to function. GOS announces a Stabilization fund __________________________________ ¶14. On October 20, the GOS announced its Stabilization plan, with steps to stabilize its financial system by guaranteeing up to USD 205 Billion of new bank borrowing and creating a fund to take direct stakes in banks. ¶15. The plan builds on the package presented at the EU level last week, and it involves a pledge to guarantee up to USD 205 Billion of new medium-term bank borrowing and a separate SEK 15 Billion (USD 2 Billion) fund that can be used to buy preference shares in any bank that needs a capital boost. As part of the legislation, which will go before parliament next week, the government will also assume the powers to take over banks. ¶16. Mats Odell, Minister for financial markets, said any institution that received a capital injection must agree to limit salaries and bonus payments to managers. Finance Minister Anders Borg further said Sweden would examine its deposit guarantee program, having this month raised the cover on bank deposits to SEK 500,000. Background about the Swedish banking crisis in the 1990's _____________________________________________ _____ ¶17. During 1991-1992, a housing bubble in Sweden deflated (housing prices in Stockholm dropped 40-60 percent),resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007-2008. In response, the government took the following actions: -- Sweden's government assumed bad bank debts, but banks had to write down losses and issue an ownership interest (common stock) to the government. Shareholders were typically wiped out, but bondholders were protected. -- When distressed assets were later sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies in public offerings. -- The government announced the state would guarantee all bank deposits and creditors of the nation's 114 banks. -- Sweden formed a new agency to supervise institutions that needed recapitalization (Bank Support Authority),and another that sold off the assets, mainly real estate, that the banks held as collateral. ¶18. This bailout initially cost about 4 percent of Sweden's GDP, later lowered to between 0-2 percent of GDP depending on various assumptions due to the value of stock later sold when the nationalized banks were privatized. Biographic information Central Bank Governor Ingves _____________________________________________ __ ¶19. Stefan Ingves is Chairman of the Executive Board and Governor of the Central Bank. Stefan Ingves is a member of the ECB General Council and a member of the Board of Directors of the Bank for International Settlements (BIS). He is also Sweden's governor in the International Monetary Fund. Stefan Ingves was previously Director of the Monetary and Financial Systems Department at the International Monetary Fund from 1999-2005 (when he played a major role in resolving the Turkish financial crisis). Prior to that, he was the Deputy Governor of the Central Bank and General Director of the Swedish Bank Support Authority. As such, he was one of the main architects of the Swedish successful response to the crisis in the 1990's. Prior to that he was Under-Secretary and Head of the Financial Markets Department at the Ministry of Finance. Stefan Ingves holds a PhD in economics. Stefan Ingves' term of office is six years from 1 January 2006. WOOD