26 October 2015

Bloomberg: Banks in Sweden told to add risk weights to government bonds

With Greece on the verge of bankruptcy numerous times over the past five years, the cat’s out of the bag: it is possible to lose money on sovereign debt. That means banks should no longer be free to operate as though that weren’t the case, according to Sweden’s Financial Supervisory Authority.

Though European regulators have been trying to address this issue, Sweden didn’t want to wait for a region-wide decision before acting, Uldis Cerps, executive director of banking at the FSA in Stockholm, said in an interview.

It makes little sense that while “sovereign risk is being priced in markets on a daily basis,” banks “would be, by the regulatory framework, allowed not to take this into account in their capital planning,” he said.

Sweden has told its four biggest banks that they can’t adopt the standardized models, which would allow them to use risk weights as low as zero on sovereign debt. Instead, they must come up with internal ratings systems and assign realistic loss probabilities to the assets. The method also needs to apply to municipal debt, Cerps said.

The regulator is now reviewing models submitted by Nordea, SEB, Handelsbanken and Swedbank, which together have assets equivalent to about four times Sweden’s gross domestic product. The Swedish Export Credit Corp. has also provided its internal ratings model for assessment.

Sweden already last year started using its national regulatory freedom under so-called Pillar 2 rules to require banks to hold capital against sovereign debt. The risk weight attached to an asset determines how much capital a bank must hold to protect it from losses.

Denmark’s FSA said it won’t follow Sweden’s lead in a step that seemingly contradicts a recommendation by the country’s central bank. Denmark also argued in favor of a more critical approach to measuring asset risks back when Basel proposed giving its AAA-rated covered bonds a lower liquidity status than sovereign debt.

Sweden’s decision to require banks to use internal models on sovereign bonds marks something of a departure from the guidance given on other asset classes. The regulator has chided banks for relying on overly optimistic internal calculations for mortgage and corporate assets.

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