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