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Martin Blåvarg
Funding the Swedish
banking system
Sweden is a small open economy with pension-oriented savings. The economy
therefore needs a banking system that can – and wants to – use bond funding both
in Sweden and abroad to finance its investments.
Handelsbanken’s Series of Small Publications No. 29
Martin Blåvarg
Funding the Swedish
banking system
Sweden is a small open economy with pension-oriented savings. The economy
therefore needs a banking system that can – and wants to – use bond funding both
in Sweden and abroad to finance its investments.
April 2013
Handelsbanken’s Series of Small Publications No. 29
Contents
Foreword
Foreword ..................................................................................... 2
The global financial crisis which started in 2007, and which is still ongoing to some
extent, has totally changed the conditions for banks’ funding. Before the crisis, almost
the only factor which determined the funding cost of a bank was the credit ratings of
the large rating agencies. And since practically all the major banks had the equivalent
of AA or A, the difference in price which banks needed to pay for their funding was
very small. The crisis has totally changed these conditions. Investors make their own
in-depth analysis of a bank’s creditworthiness, and practically ignore the ratings from
the agencies. A vital part of this analysis aims to understand how banks obtain their
funding. Since the crisis has shown how important it is that banks manage their liquidity
situation well, investors spend a lot of time and resources on trying to understand the
banks’ funding situation and making sure that they do not assume an unmanageable
liquidity risk.
For the past three years, I have been responsible for Handelsbanken’s investor
relations in the US. I have met over 200 North American debt investors, most of them
on several occasions. With its extremely conservative approach to risk and its streamlined business model, Handelsbanken has become one of the most popular banks
with American investors during the crisis. Investors particularly appreciate the Bank’s
extremely low loan losses, its high, stable return on equity throughout the crisis and
the fact that the Bank has managed by itself and not used government financing.
However, it has been necessary to explain to investors why Handelsbanken – like the
other Swedish banks – has a low proportion of deposit funding and why we use the
international securities markets for our funding. And also why we actually think this is a
much more responsible way of funding a bank, which reduces the Bank’s liquidity risk,
compared with only relying on government-subsidised deposit funding.
This publication intends to provide a more detailed presentation of why Swedish
banks obtain funding on the bond markets to such a high degree, both in Sweden and
abroad. It also attempts to explain why this should be seen as a positive factor for the
stability of the banking sector while it also leads to a banking system which can efficiently perform one of its most important tasks – that of supporting Sweden’s economic
growth by ensuring that capital is available for investment.
Summary..................................................................................... 3
Introduction.................................................................................. 4
Savings and investments in the Swedish financial system
and the implications for banks’ funding........................................ 5
Development of savings and funding in Sweden..................... 6
The current structure of the Swedish financial system............. 7
Driving forces behind Swedish banks’ international funding...... 8
Securities funding dominates international funding................ 10
Currency risk management of Swedish institutional
investors is an important factor behind Swedish banks’
short-term international funding............................................. 13
Liquidity risk management – the most important factor for
banks’ funding............................................................................14
Overall funding structure of Swedish banks........................... 15
Is a low proportion of deposit funding a disadvantage
for Swedish banks?................................................................17
Can the banks increase their deposit funding to a
significant extent – and is this desirable? .............................. 19
Does foreign funding entail higher liquidity risk for
Swedish banks?.................................................................... 22
Socio-economic perspectives on banks’ funding....................... 23
Does the economy need a higher level of deposit funding?...... 24
Socio-economic aspects of foreign funding.......................... 25
1
2
Summary
The international financial crisis of recent years has put the risk in banks’ funding in the
spotlight. In particular during 2007 and 2008 – the first years of the crisis – it became
clear that the short maturity for many banks’ funding made them unable to continue without government support when investors lost confidence in their ability to survive. Since
then, both banks and authorities have taken a number of measures to reinforce banks’
ability to withstand a situation in which a bank’s lenders risk withdrawing their funding.
This publication discusses two distinctive features of Swedish banks’ funding that
have been the subject of debate in recent years. The first issue is to what extent
the banks use deposits as a source of funding. The publication discusses whether
deposits really are as superior a source of funding as authorities, rating agencies and
other financial players like to claim. The stability of deposits is based on government
guarantees rather than an assessment that banks are taking low risk. It is therefore likely
that the risk of sudden outflows is underestimated and that this risk may increase in
the future. But there are arguments in favour of a diversified funding base with a high
degree of long-term bond funding being a better way to minimise banks’ liquidity
risk. When a bank obtains long-term funding, the maturity of the lending and funding can be matched, thus minimising the liquidity risk. As there is always some risk of
deposits being withdrawn, deposit funding will involve an element of liquidity risk in
all circumstances, which can make long-term bond funding a better source of funding for banks. In addition to the bank’s need to minimise its liquidity risk, it may also
be doubtful whether increased deposits are particularly attractive from the savers’
perspective, since their savings largely consist of pension savings focusing on longterm high return.
The second issue that has been discussed refers to Swedish banks’ use of international funding. The need for international funding stems from the fact that Swedish institutional investors increasingly want to invest in international assets and use Swedish
banks for currency hedging of these investments. By obtaining international funding,
Swedish banks ensure that the Swedish economy gains access to international capital,
which is necessary to avoid a lack of capital arising when Swedish savings are invested
in the economies of other countries to a major extent. Swedish banks also enable
institutional investors to hedge their foreign currency investments by entering into swap
agreements with them. These swaps are financed through international funding. The
international funding could pose a problem if Swedish banks took liquidity risk in the
foreign currency and made themselves dependent on continually having access to
international markets for their survival. But if the banks match their assets and liabilities
in foreign currency, this kind of liquidity risk will hardly arise. This is the case for
Handelsbanken. Short-term funding is used either to finance liquid assets in the foreign
currency, or it is swapped to Swedish kronor. This means that Handelsbanken does
not risk having a lack of liquidity in the foreign currency, even if the access to international funding suddenly ceased. With this use of international funding, international
3
financing is positive, because it gives the bank more diversified funding, and in socioeconomic terms, has a generally positive effect as a channel for providing the Swedish
economy with international capital.
Introduction
The dependency of Swedish banks on international market funding is an issue of concern
to Swedish authorities. The Riksbank (Sweden’s central bank) and the Swedish Financial Supervisory Authority have claimed that the banks’ international funding is a risk
factor for the Swedish banking sector. The reason they give is that there is a higher
liquidity risk in obtaining funding abroad, because international lenders have a greater
tendency to cease their funding activity if the creditworthiness of Swedish banks is
called into question. The authorities have therfore started to discuss limitations of this
funding in one way or another.
So far, the debate has been conducted with a fairly limited perspective, assuming
as its starting point that banks select a funding structure on the basis of their own
purely business considerations. The discussion has not, however, fully taken into
account how the financial system at large is structured, nor the needs or preferences of
the Swedish collective of investors. This publication tries to place the banking system’s
funding in a wider context, above all by highlighting the existing driving forces and
conditions for Swedish households’ savings activity, and also for the different types of
institutional investors that largely manage household savings.
A special aspect of the banks’ funding is the extent to which traditional deposits are
used as a source of funding. The debate often claims that Swedish banks should use
deposits for funding to a greater extent, because many people perceive this as a more
stable source of financing than funding via interest-bearing securities or funding from
banks and other financial institutions. But there is reason to question this perception,
both whether deposits in general can be expected to be more stable than other funding and whether, in other respects, it is desirable or even possible for Swedish banks to
try and replace international market funding with deposits to a substantial extent.
The first section of the publication discusses how the Swedish financial system
channels savings on an overall level, and how this affects banks’ funding. The second
section highlights central considerations for the banks when they structure their funding,
with special focus on the conditions for deposit funding. The final section discusses the
socio-economic implications of Swedish banks’ funding.
4
Savings and investments in the Swedish financial system
and the implications for banks’ funding
The following section describes how Swedish savings have developed over time
and what this has entailed for the structure of the Swedish financial system both in
general terms, and more specifically for Swedish banks’ funding.
One of the basic tasks of the financial system is to redistribute savings to investments,
which is a central function for creating economic growth and prosperity. Savings cannot
be easily transferred from the players that have a surplus to the players with investment
needs, which is why there are various forms of financial intermediaries1 to facilitate this
redistribution. Banks receive savings in the form of deposits and lend them to households
and companies with investment needs. Insurance companies and mutual funds (institutional investors) receive savings and invest them in equities and bonds, which are issued
by companies that need funding. The supply of funding in an economy therefore depends
on the sum of savings available. In an economy which is not open to other countries, the
supply of funding is totally dependent on domestic savings. In a small open economy
such as the Swedish economy, interaction with the surrounding world plays a major part.
For various reasons, Swedish households and companies wish to invest some of their
capital abroad – not just in Sweden. Conversely, there are grounds for trying to obtain
capital from abroad, so that a lack of capital does not limit the conditions for investments.
Figure 1 is a simplified diagram showing the most important flows in this respect.
Development of savings and funding in Sweden
A number of factors have been important as to how the channelling of savings has
developed in Sweden, and these factors differentiate the Swedish financial system from
that of other countries:
n
Bonds (> 2 yrs)
Short-term financing SEK (< 1 yr)
Instuonal
investors
din
g,
fun
Lo
for ngeig ter
n m
ig
re
fo
Sh
for orteig ter
n m
t,
en
stm
ve
In
fun
din
g,
Figure 1: Illustration of savings and investment flows between banks, institutional investors
and the real economy (private individuals and companies).
s
sit
ire
nd
Fo
rei
g
Le
nd
ing
ct
po
De
ts
en
ym
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ium
io
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pe en
/p
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nd
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Fu
d u Inv s
un ts nd
l f en bo
ua m &
ut it s
M mm uie
co eq
in
inv
es
tm
en
t
Banks
Derivaves
Short-term financing
foreign currency
Private
individuals,
companies
etc.
1 Intermediaries act as a link between savers and those who need money for investments. Intermediaries
manage information problems and use economies of scale to efficiently channel savings to investors. Typical
financial intermediaries are banks, life insurance companies and funds.
5
1. Swedish housing has long been primarily financed through bonds issued by special
mortgage institutions. The mortgage institutions gained special significance as a
source of funding for the major housing construction projects in the 1960s and
1970s. Since then the system for funding housing has been modernised in many
ways. For example, government support for this type of housing funding no longer
exists, and a market has developed for European-style covered bonds as a tool for
financing housing in Sweden.
2. Swedish households save substantially for their pensions, and they do so to a
considerable degree through the national pension system, via collectively-agreed
occupational pensions and private pension insurance. Households therefore have
a long-term perspective on their savings, which benefits investments in assets that
have expected long-term high return, such as equities and long-term bonds. To a
large extent, saving takes place through insurance companies and various funds, so
the combined savings are largely invested in bonds and equities. This type of saving
has increased significantly since the end of the 1990s when the pension system
was reformed. In addition, in an international comparison, Sweden has a welldeveloped welfare system, which protects Swedish households effectively in the
event of unemployment or long-term illness, for example. These institutional conditions have a major impact on households’ private savings and reduce the need of
having large sums of money in deposit accounts as a buffer for unforeseen events.
The supply of funding through mortgage bonds combined with households’ preferences
for their savings has reduced the importance of deposits as a source of funding for
Swedish banks. During the period when the banking system was strictly regulated
until 1985, with regulation of both interest rates and supply in the credit market, banks
were unable to create an attractive deposit product. In this period, private savings focused
on equities and eventually on mutual funds, for example through the government’s focus
on public savings programmes in mutual funds with taxation benefits. High inflation also
contributed to making fixed income savings a generally unattractive option. When the
banking system was liberalised in the 1980s, lending grew substantially, but since
this mainly comprised mortgage lending, a large part of the need for funding was
met through mortgage bonds. The banks therefore continued to develop fund-based
6
saving, and with households’ long-term focus for their savings, this was well suited
to households’ preferences. The equity market also performed very well in the latter
part of the 1990s, which contributed to households’ interest in equity-oriented savings.
The introduction of the pension reform towards the end of the 1990s helped to reinforce
this trend. The reform of the AP National Pension Insurance Funds was also particularly
significant as it gave the funds much greater possibilities of investing in international
assets. The AP funds drastically reduced their investments in Swedish mortgage bonds
in conjunction with this.
The current structure of the Swedish financial system
The channelling of households’ savings and how this affects banks’2 funding can be
summarised by presenting an overall picture (see Figure 2).
Figure 2. The link between Swedish households’ savings and the banking system’s
funding of the Swedish real sector.
Household
Banks & mortgage institutions
5,000,000
Savings in mutual funds &
insurance companies
Savings in government
instruments
Shares
2,000,000
Bank deposits & banks’ bonds
1,000,000
3,000,000
Institutions’ investment in
bonds etc.
2,000,000
Holdings of government
instruments
0
Institutions (insurance companies, mutual
funds etc.)
Corporate lending/deposits
1,000,000
0
Savings abroad
3,000,000
Household lending/deposits
Assets
5,000,000
Liabilities
The non-financial companies’
investments are not shown
separately since they mainly
comprise bank investments
and shareholdings (mainly
within the same Group)
Instuons invest with banks to a
certain extent, mainly in mortgage
bonds, since they have a long term
perspecve on their investments But a
large part of the investments go to
foreign assets.
Outside Sweden
4,000,000
3,000,000
Government instruments and
other public sector
2,000,000
Shares and bonds in Swedish
companies
1,000,000
Mortgage bonds and other
investments in Swedish banks
0
Source: Statistics Sweden, Financial accounts
2 Here, and in the rest of this publication, the word “banks” is used synonymously with credit institutions,
i.e. also to include mortgage institutions and other credit market companies, because in terms of function
they perform similar tasks to banks and because significant parts of large banking groups’ operations are
performed in such subsidiaries. When statistics are presented, they refer to what the Riksbank (Sweden’s
central bank) calls monetary finance institutions (MFI), which include credit institutions and certain securities
companies that accept deposits.
7
Driving forces behind Swedish banks’ international funding
A large part, about 44 per cent, of the institutions’ investments go outside Sweden. It
is natural that a relatively large proportion of pension funds are invested internationally.
Diversifying savings so that they are not only affected by conditions in the Swedish
economy is rational, irrespective of whether households determine their investments
themselves by choosing funds in various savings products, or whether a professional
manager takes care of the asset allocation, for example in traditional life insurance
companies. Here we see a degree of difference between savings products, where
households carry the entire investment risk themselves – for instance with mutual
funds – and savings products, where the institution carries part of the risk by guaranteeing the saver a certain return; this applies above all to the traditional life insurance
companies. For life insurance companies, households’ savings are regarded as a commitment determined as an amount in Swedish kronor. This means that international
investments give rise to an exchange rate risk, which limits their will and opportunities
6,000,000
SEK m
SEK m
4,000,000
The net of the amount
other sectors invest with
the banks and what the
banks need in loans must
be financed abroad
SEK m
Only a small amount of 6,000,000
household savings go to
the banks in the form of
5,000,000
deposits and
investments in bonds
4,000,000
As shown in the figure, households’ savings in the form of deposits in banks and direct
investments in the banks’ and mortgage institutions’ bonds represent a relatively small
proportion, about 24 per cent, of households’ total savings3. The large part of households’ savings is attributable to investments in what are referred to here as institutions
– primarily equity funds, fixed income funds and life insurance companies. This type of
saving mainly focuses on pensions, but normal fund savings are also included here.
The figure also includes institutions4 that do not manage households’ savings
directly, such as the AP National Pension Insurance Funds, with the aim of highlighting
how the institutions as a whole invest their assets. The institutions generally have a
long-term perspective on their investments and invest in equities and in bonds issued
by both banks (primarily mortgage institutions) and by the government.5
3 The proportion, 24 per cent, differs from the 18 per cent that is stated elsewhere in the document as
the deposits’ proportion of Swedish households’ savings. This is partly because savings in banks’ bonds
are also included here. Unlisted equities are not, however, included in the savings figure mentioned here,
because they are not regarded as financial investments.
4 Institutions refers to the institutional investors who manage large asset values in the Swedish financial
system and who are therefore important as managers of households’ savings or (as is the case for the AP
National Pension Insurance Funds) who are important investors in the Swedish capital market – even though
they do not directly manage households’ direct savings. The data come from the financial accounts and they
encompass, among other things, insurance companies, other forms of pension institutions, equity funds and
fixed income funds, including savings in the PPM premium pension funds system and the AP pension funds.
5 In the figure, households’ total savings in institutions are lower than the total balance sheet for the institutions. The most important reasons for this difference are that the government accounts for a certain part of
these savings in the AP pension funds, the institutions may have certain assumptions or liabilities that do
not represent savings, and the institutions invest in each other to a certain extent (for example an insurance
company that invests in a fund), which inflates the total balance sheet.
8
6 When households purchase funds that invest internationally this also involves a currency risk. However,
these fund investments largely tend to comprise equity funds, and for volatile assets such as equities –
where the price varies considerably – it is natural to see the currency risk as part of the total price risk and
not to take this into special consideration. If, however, there is a commitment that is established in a certain
currency, the currency risk is more important to take into consideration.
9
tional investors have decided which currencies they can invest in, and for fixed income
investments, normally only the largest investors are able to invest in a small currency like
the Swedish krona. If international investors were willing to invest in Swedish kronor,
it would be possible for Swedish banks to compensate for the deficit in funding from
Swedish investors by issuing more bonds in Swedish kronor and obtaining larger
investments from international investors in this market. Due to institutional investors’
normal investment regulations regarding currency exposure, the opportunity of this
occurring is limited.
Securities funding dominates international funding
In the light of this, Swedish banks partly obtain funding internationally. The international
funding is primarily obtained through issues of securities in the form of certificates and
bonds. International funding has increased in the past 15 years, mainly because banks’
lending increased during the period. The growth of deposits has been stable and relatively
good, but has not kept up with the lending growth. This has necessitated greater securities funding to support growth in the Swedish economy (see Figure 3).
Figure 3. Swedish banks’ lending, deposits and securities funding
6,000
5,000
Issued securities
Loans from the public
4,000
SEK bn
Deposits from the public
3,000
2,000
Jan-11
Aug-11
Jun-10
Apr-09
Nov-09
Sep-08
Jul-07
Feb-08
Dec-06
Oct-05
May-06
Mar-05
Jan-04
Aug-04
Jun-03
Apr-02
Nov-02
Sep-01
Jul-00
Feb-01
Dec-99
Oct-98
0
May-99
1,000
Mar-98
to invest in international assets6. The institution must balance the need for diversification
against the increased risk created by the currency risk. This balancing requirement is
expressed in the internal investment regulations and the regulations that institutional
investors must comply with. The AP pension funds do not have the same type of commitments as the life insurance companies, but their commitments as buffers for the
Swedish government’s pension payments established in Swedish kronor mean that
they must also balance these two interests. These institutions are therefore also bound
by limitations in terms of how much they can invest internationally. Although limitations
on international investments apply to many major institutions, the proportion of international investments is large. It has also increased, from about 10 per cent of the total
assets in the mid-1990s, to in excess of 40 per cent today.
When Swedish banks have to make a decision on how to obtain funding, it is
important to form an opinion on these supply and demand conditions. If the interest
rate is raised or lowered for deposit accounts, to what extent will this lead to increased
or decreased flows into the bank’s deposit accounts? How will the issued volumes
of mortgage bonds in the Swedish market affect the interest rate that the investors
demand in order to purchase the bonds? And how does the cost of these sources of
funding relate to the cost of obtaining funding from international sources? The banks
do not, however, only have to take account of these cost aspects. How the choice of
funding affects the bank’s liquidity risk is at least as important, so that the bank can
ensure its long-term capacity to fulfil its commitments. Important aspects here are
that the bank aims to obtain diversification in its sources of funding, that there must
be a balance between maturity of the assets and liabilities, and that the banks need
to maintain certain buffers in their balance sheets with which to manage unexpected
changes in their payment flows. Banks manage their liquidity risks by effectively matching maturities of assets and liabilities, by issuing long-term bonds, and by distributing
funding in various Swedish and international markets. This reduces the problem that
would arise if performance in any individual funding market suddenly deteriorated. The
banks’ total funding structure is thus a result of how the liquidity risk can be managed
and what costs apply to different types of funding sources.
One special aspect of Swedish banks’ funding is the fact that the Swedish krona is
a small currency. As a result, international investors are less inclined to invest in assets
denominated in Swedish kronor than in other, larger currencies. For equity investments
this is not particularly important, and the proportion of international ownership on the
Nasdaq OMX Nordic Stockholm stock exchange is relatively high. However, for fixed
income investments, currency has great significance. In their guidelines, most institu-
Source: Statistics Sweden. Note: The increase in 2001 is due to the fact that international lending and
deposits were added to the statistics.
10
About half of Swedish banks’ securities funding takes place abroad. The proportion
of international funding has not changed to a greater extent in the past 10 years (see
Figure 4). However, a major change took place in the distribution of currencies in the
early 2000s when international funding increased from just under 30 per cent to more
than 50 per cent in the space of just a few years.
Figure 5. Swedish institutional investors’ assets distributed by asset type, proportion of
total investment assets
100%
90%
Figure 4. Currency distribution for Swedish banks’ securities funding
100%
80%
70%
90%
80%
Swedish kronor
70%
Foreign currency
Foreign assets
Other
Shares
Mutual funds
Banks & mortgage institutions
Sovereign
60%
50%
40%
60%
50%
30%
40%
20%
30%
10%
20%
0%
0%
Mar-98
Sep-98
Mar-99
Sep-99
Mar-00
Sep-00
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
Mar-10
Sep-10
Mar-11
10%
Source: Statistics Sweden
The transition to a larger proportion of international funding coincided with institutional
investors starting to buy assets abroad to an increasing extent (see Figure 5), which, as
previously discussed, largely stemmed from the reforms implemented in the Swedish
pension system in the late 1990s. Here too the change thus mainly took place more
than 10 years ago. The need for banks to increase their proportion of funding in foreign
currencies thus coincides with the decision made by Swedish institutions to increase
their investments in foreign currencies.
11
Source: Statistics Sweden
An important change from the investors’ perspective is that the government’s borrowing
needs and therefore the supply of government bonds have decreased dramatically in
the past 15 years. The proportion of investments in Swedish government securities has
decreased from nearly 30 per cent to less than 10 per cent of the total assets among
institutional investors. This has probably contributed to the increased interest in fixed
rate international investments, because the supply of bonds with sovereign risk is
so limited in Sweden. Another circumstance that is significant to Swedish investors
is that there are so few bond issuers in the Swedish market. Of the total volume of
bonds in Swedish kronor, banks and mortgage institutions account for 60 per cent of
the outstanding volume, the government for just under 30 per cent, and other issuers
for just over 10 per cent. In view of investors’ need for diversification, it is natural that
12
there is interest in increasing their investments in international bonds. Large volumes
of non-financial corporate bonds are issued in the euro and dollar markets, and there
is naturally great interest in being able to invest in this asset type as well. This was
particularly true during the recent crisis, when many governments and banks had
problems internationally, and non-financial corporate bonds became one of the most
attractive forms of investment in the global capital markets.
Currency risk management of Swedish institutional investors is an important
factor behind Swedish banks’ short-term international funding
A particular consequence of Swedish institutions’ investments in foreign currencies is
that they often need to manage the currency risk by entering into derivative contracts.
This is due to the limitations mentioned above for the AP National Pension Insurance
Funds and the traditional life insurance companies in terms of investments in foreign
currencies. These institutions normally have the possibility of investing more in foreign
currencies than their investment guidelines stipulate, if they hedge their positions. This
hedging mostly takes place by the investor entering into a currency swap contract
with a Swedish bank, through which the bank undertakes to pay a specific value in
Swedish kronor to the investor on a future date, in exchange for the investor paying
the bank a specific value in a foreign currency (see Figure 6). The investor thereby has
a position in Swedish kronor instead of in foreign currency. The bank, however, takes
a position in foreign currency, but this can be managed by the bank obtaining funding
in the foreign currency with the same maturity as the swap. The bank thus removes its
currency risk, which means that the bank obtains funding in Swedish kronor instead of
the foreign currency. At maturity, the bank repays the certificate and the swap is dissolved by the Swedish institution paying the bank the value of the swap in the foreign
currency, while the bank repays the agreed sum in Swedish kronor. For the bank this
process means that the foreign currency funding is converted into funding denominated
in Swedish kronor.
Figure 6. Illustration of how Swedish banks hedge the currency risk of Swedish institutions
by obtaining foreign currency funding and entering into currency swap contracts
Time 1:
1. The bank sells certificates in foreign
currency with short maturity
Foreign investors needing to
invest short term and at low
risk e.g. money market fund
Time 2:
13
1. The swap means that the bank
lends foreign currency to the institution
which in turn lends SEK to the Bank
Swedish bank
2. The bank repays
the certificate
Swedish institutional investor
needing to hedge long-term
foreign currency investments
2. The swap expires, the institution
repays foreign currency to the bank,
the bank repays SEK to the institution
An important consequence of this process is that the bank does not acquire a liquidity risk in the foreign currency. It is common for these swaps to be “rolled over”, i.e. a
new, similar contract is entered into when the swap expires. The usual life of these
swaps is three months. If for some reason the bank cannot or does not wish to obtain
foreign currency funding, it can decide not to enter into a new swap contract with the
investor. The bank will then have a liability in Swedish kronor that needs to be funded;
the liquidity risk does not therefore disappear, but it arises in Swedish kronor and not
the foreign currency. It is thus important that the bank does not rely on this funding for
illiquid lending. For Handelsbanken, it is of central significance to liquidity risk management that this is the case.
Correspondingly, the investors run a risk that the swap cannot be extended, because in this case they risk having an excessively large position in foreign currency. If
investors cannot find a bank with whom to do the swap, they may need to sell foreign
assets to manage their position. However, it should be emphasised that this is an extreme situation where it is impossible to enter into short-term currency swap contracts
in Swedish kronor. For this to occur, a very serious crisis in the financial markets would
have to take place. In such a situation, it is conceivable that the institution may do
the swap with an international bank instead. But in such cases, the international bank
would gain a surplus in Swedish kronor that would need to be invested somewhere in
the Swedish financial system. As assets and liabilities in Swedish kronor constitute a
closed system, Swedish banks have good opportunities of accessing these funds in one
way or another. Furthermore, the socio-economic effects of temporary disruptions for
asset managers to hedge their foreign currency assets in this way should be limited.
The volume of foreign financing that Swedish banks engage in for this purpose
is substantial. There are no detailed statistics on this, but an outline summary of the
positions of six of the largest institutional investors shows that their combined currency
hedges amount to nearly SEK 600 billion. In practice, this means that some of the
short-term funding required by Swedish banks in Swedish kronor can be managed
through funding in foreign currency. However, if the banks did not do this, the Swedish
institutions would need to invest more in Swedish kronor – and there would thus be a
supply of Swedish krona funding for the Swedish banks.
Liquidity risk management – the most important factor for
banks’ funding
The preceding section focused on demand from savers and its effects on banks’ funding.
From Handelsbanken’s internal perspective, however, the most important aspect of
funding is that it must be structured to limit the Bank’s liquidity risk as far as possible,
14
rather than based on cost-related considerations due to demand for investment opportunities. Liquidity risk and its management have become increasingly important,
especially after the global financial crisis that began in 2007. At that time it became
clear that many banks had taken on excessive liquidity risk. They were then unable to
manage the very limited supply of funding during the severe market turbulence that followed, especially after the collapse of the American investment bank Lehman Brothers
in September 2008. When the financiers lost confidence in the ability of these banks
to survive, it became clear that they could not survive without government support,
and central banks and governments implemented a number of measures to ensure
the liquidity of individual banks and the national banking systems. In Sweden this
became clear for three of the largest banks which were forced to obtain funding from
the Swedish central bank in 2008. Handelsbanken’s conservative view of liquidity risk
meant that the Bank was instead a very large (SEK 100 billion) depositor in the Riksbank at the height of the crisis. Since then, both banks and authorities have taken
a number of measures to reinforce banks’ ability to withstand a situation in which a
bank’s lenders risk withdrawing their funding.
In this context we will not discuss all aspects of Handelsbanken’s liquidity risk7, but
will mainly focus on those aspects that affect funding of the Swedish banking system
as a whole. The description is based on how Handelsbanken views its funding, though
there are certain differences between the conditions and strategic choices Handelsbanken makes compared with other Swedish banks. However, certain general behavioural patterns can be observed based on more universal considerations that Swedish
banks must take into account when structuring their funding, which also shows how
funding of the Swedish banking system has developed as a whole.
15
Modern banks have a large amount of assets and liabilities which are not loans and
deposits. For example, banks hold interest-bearing securities both for trading purposes
and as a liquidity buffer. Banks also lend and borrow money among themselves to support liquidity management and financial trading, and banks trade in derivatives, both
on their own behalf and on behalf of their customers (see figure 7). Banks also have
the opportunity to issue interest-bearing securities (bonds and commercial paper) as
an alternative to deposit funding. Interest-bearing securities have a great advantage for
both the bank and the investor. The bank can obtain a longer maturity on its funding
and thus reduce liquidity risk compared with money directly available to the depositor.
Investors can get higher interest on their investment when lending money for a long
time, but do not have to tie up the money as it would be if deposited in a fixed-term
deposit account, since the securities can be bought and sold in financial markets.
Figure 7. Swedish banks’ assets and liabilities as at 31 October 2012
SEK m
12,000,000
Other
10,000,000
Shares, subordinated loans, other equity
Derivatives
Loans and deposits foreign banks
8,000,000
Loans and deposits Swedish financial companies
Interest-bearing securities – certificates
Overall funding structure of Swedish banks
Historically, the fundamental role of banks has been to receive deposits from participants
in the real economy (households and companies) that do not need the money at the time
and lend it to other participants. The bank creates socio-economic value by assessing
the creditworthiness of borrowers and allocating capital to those borrowers who, taking
risk into account, have justifiable financing needs. The bank provides value to depositors
because deposits are accessible on short notice and thus meet the need for liquidity.
One of the most important consequences of this according to classic banking theory is
that the bank takes on substantial liquidity risk, since lending is illiquid – it is impossible
to quickly dispose of it – while deposits are liquid, in the sense that funding can quickly
disappear from the bank’s balance sheet. This could happen primarily if depositors
lose confidence in the bank and withdraw their funds, fearing that they would otherwise
lose their money.
Source: Statistics Sweden
7 For a more detailed description of liquidity risk management, please see Handelsbanken’s annual reports
“Risk and capital management – information according to Pillar 3
A fundamental principle for bank funding is that to some extent the bank matches the
maturity of assets and liabilities. Deposits from customers are liquid in the legal sense as
6,000,000
Interest-bearing securities – bonds foreign currency
Interest-bearing securities – bonds SEK
Lending to
real sectors
is met by
deposits
from these
sectors and
bond
funding.
4,000,000
2,000,000
Interest-bearing securities – assets
Loans and deposits foreign public
Loans and deposits Swedish public sector
Loans and deposits Swedish companies
Loans and deposits Swedish household
0
Assets
Liabilities
16
mentioned, because they are available to the depositor at short notice. But deposits
have increasingly come to be regarded as a stable source of funding. The most important
reason is that a large portion of deposits are guaranteed by the government through the
deposit guarantee, so depositors have no reason to withdraw their funds if the bank
should develop any problems. It should, however, be stressed that a large part of the deposits exceeds the guaranteed level of a maximum of 100,000 euros (or the equivalent)
per depositor. The funds which exceed this level, which mainly refers to most of corporate
deposits, are price-sensitive and can be moved easily between banks depending on the
interest rate offered. Other aspects also probably play a role; for example, non-guaranteed
depositors also expect that the government will support banks if they have problems.
Despite all the bank failures in recent years, few examples can be found of private depositors who lost money with investments in deposit accounts. Against this background,
traditional household deposits from bank customers in the real economy are increasingly
considered to be a source of stable funding, even in situations of financial stress.
As previously discussed, access to traditional deposits as a source of funding for
Swedish banks is not adequate to cover the existing needs to finance lending. The difference between deposit assets and lending needs is primarily covered through longterm borrowing in the bond markets. Deposits from customers in the real economy and
long-term bond borrowing cover lending to the real economy on an aggregate basis.
The liquid assets are financed through short-term borrowing. Lending and deposits
between banks largely cover each other, both among Swedish banks and in relation to
foreign banks, as do derivative positions which are mainly the same size on both sides
of the balance sheet.8
Below we discuss whether the specific circumstances that Swedish banks have
because of the structure of the Swedish financial system create a problem for funding,
especially considering the low percentage of deposit funding from households and the
high use of foreign market borrowing.
Is a low proportion of deposit funding a disadvantage for Swedish banks?
As shown above, Swedish banks have a relatively low proportion of deposit funding.
Most other banking systems, especially outside the Nordic countries, have a significantly
higher degree of deposit funding from households, which is reflected in the fact that
the percentage of deposit savings of total financial assets for Swedish households
only amounts to 18 per cent, to be compared, for example, with an average of 36 per
cent for the eurozone. We have previously discussed the reasons for the low percentage
of deposit funding and how bond-based home funding combined with a strong welfare system and savings focused on pensions result in lower demand for deposits. At
the same time that these structural conditions exist, considerable scepticism to market
8 It should be noted that in this respect the major banks differ to a large degree. Handelsbanken’s derivative volumes correspond to only around 7 per cent of the total outstanding derivatives of the major banks.
17
funding has emerged, such as from regulators and rating agencies. However, there
are reasons to question the extent to which the low percentage of deposit funding really is a disadvantage for Swedish banks and thus this view should be discussed from
different perspectives.
Structural factors are not the only underlying factors that explain the low percentage
of deposit funding. Using long-term bond loans as a complement to deposits offers a
number of advantages. The advantage of bond funding is that the bank, in contrast to
deposit funding, knows for how long the money will be available and what the cost will
be throughout the time to maturity. There is no liquidity risk during the life of the bond.
Bond funding is also necessary for the aim to diversify the funding sources as far as
possible. If only deposits are used, diversification is not achieved.
One specific advantage for Swedish banks is that the domestic market for covered
bonds serves as the base for market borrowing. This market has demonstrated a high
degree of stability, which is natural due to its significance for the Swedish financial system. Covered bonds account for almost half of the outstanding volume on the Swedish
bond market and all the major institutional investors have considerable exposure in this
market. The market remained stable during the crisis in the 1990s, as well as during
the turbulent years for the Swedish bank market, 2008 and 2009.
The view of deposits, including the parts of deposits which are not state-guaranteed,
as a stable source of funding in all situations may be misleading and in many regards,
risky. Deposits can normally be withdrawn immediately, which means that banks that
encounter financial problems rapidly risk losing their funding in what is known as a
bank run. Despite this risk, deposits are still regarded as a stable source of funding
even in times of financial turbulence, mainly because of the behaviour of household
depositors observed in the majority of banking crises in recent years. Private savers
have only withdrawn their savings deposits to a limited extent. In many cases, household deposits have proven to be a stable source of funding for banks even in critical
situations, probably because they are often guaranteed via deposit guarantees. There
are a number of reasons, however, why this behaviour may change and the liquidity
risk in deposits may increase:
• When the entire banking system experiences problems, it is likely that depositors
expect the banking system to receive support. It may be difficult to find alternative
banks to transfer deposits. The crises of recent years have largely consisted of system
problems of this type. If just one bank were affected instead, deposits might well
become more volatile. For corporate deposits, this is a clearly observed fact.
• Globally, there is a growing political will that bank problems should not need to hit
the tax-payer. This has been shown in the case of the Cyprus crisis, for example,
where the international support efforts demanded that depositors not covered
by the government guarantee should carry losses to cover losses arising in the
18
• As it becomes increasingly common for bank transactions to be carried out online,
it becomes easier for private individuals also to transfer funds from one bank to
another. When moving money becomes simpler, depositors may conceivably act
more rapidly and more drastically in the future, even in response to unfounded
rumours about bank problems spread via social media, for example.
• There may be reasons for depositors to suddenly move their deposits other
than the bank being perceived as risky. For instance, they may receive a more
attractive offer from a different bank, or they may wish their savings to be used
for a specific ethical purpose. It is well-known that corporate deposits are quickly
moved at the best price even in normal market situations, and it is conceivable
that this may well apply to households to an increasing extent in the future. The
opportunity for private individuals to quickly open accounts and transfer money
between banks online also greatly increases the risk of increased volatility of
household deposits in general.
• It is also important to note that some deposits from companies are already extremely
price-sensitive and volatile, making them obviously less suitable as a source of
funding for banks’ long-term borrowing. This particularly applies to deposits from
large companies, in which the investment is regarded as an alternative to other
financial investments. For small companies, deposits are sometimes part of cash
management, and the amounts are smaller. Consequently, relationship-based
deposits from small companies are more stable in the same way as household
deposits. It is therefore important to consider deposits from different types of
corporate customers in different ways.
which varies over time, and it is difficult for the bank to influence the supply of funding.
The bank can influence supply to some extent through the interest rate offered, but this
is only possible to a marginal extent. Several factors other than interest rates influence
customers’ willingness to deposit money into deposit accounts, including the expected
return on other investment opportunities such as fixed income and equity funds, or the
customer’s needs for cash and cash equivalents. Moreover, major changes in the interest rate can occur through interest rate changes that are ultimately determined by the
Riksbank. Any changes in the deposit margin are small from the customer’s perspective,
compared with the changes resulting from changes in interest rates.
Against this background, the correlation between growth in deposit volumes and
interest rates is weak (see figure 8). For corporate deposits, growth seems to be the
reverse of the expected: growth in deposits actually tends to decline when interest
rates go up and vice versa. In the case of households, there seems to be some correlation
with the major shifts in interest rates, at least in recent years.
Figure 8. Annual growth rate in corporate and household deposits and average
interest rates on loans and deposits for each sector
25.00
20.00
15.00
Per cent
banking system. This is a clear example where, if the situation becomes sufficiently
serious, there is no reason for holders of deposit accounts to expect the risk in their
investment to be any lower than for bond investors. Awareness of this risk will lead
to depositors being more inclined to withdraw their funds at an early stage if the
risk of financial problems in a bank starts to look serious.
10.00
5.00
0.00
19
Household interest
Corporate deposits
Oct-12
Mar-12
Jan-11
Aug-11
Jun-10
Apr-09
Nov-09
Sep-08
Jul-07
Feb-08
Dec-06
Oct-05
May-06
Mar-05
Jan-04
Aug-04
Jun-03
Apr-02
Nov-02
Sep-01
Jul-00
Corporate interest
Feb-01
Dec-99
Oct-98
-10.00
May-99
Can the banks increase their deposit funding to a significant extent – and is
this desirable?
Against this background, it is questionable whether generally increased deposit funding
is desirable. Even if this were the case, it is debatable whether it is feasible to substantially
increase the supply of deposit funding. In the commercial paper and bond markets, a
bank can choose to issue a certain volume, at the price that the market decides, and
thus ensure that a certain funding volume is available during the specified maturity.
Deposits come to the bank based on the independent behaviour of the customers,
Mar-98
-5.00
Household deposits
Source: Statistics Sweden
20
However, if we look at the part of pricing that the bank actually influences, the margin
between interest rates and deposit rates, demand is completely the reverse of what
would be expected (see Figure 9). When the deposit margin improves from the customer’s
perspective (i.e. the deposit rate approaches the market rate), growth will fall. This
trend is not as strange as it may seem, because this margin tends to decrease when
interest rates are low, and increase when interest rates are high. Nevertheless, interest
rates clearly have a major and decisive impact on savers’ demand for deposits. Even
though banks’ interest rate policy has a dampening effect on changes in general interest rates, it cannot compensate for changes in the level of interest rates.
Figure 9. Annual growth rate in household deposits and the deposit margin (margin between 3 months STIBOR and the average interest rate on deposits for households)
25
20
Per cent
15
10
5
Growth rate of household deposits
Margin market-/deposit rate
Market rate
Household deposit rate
jul-12
feb-12
apr-11
sep-11
jun-10
nov-10
jan-10
aug-09
okc-08
mar-09
may-08
jul-07
dec-07
feb-07
apr-06
sep-06
jun-05
nov-05
jan-05
aug-04
okc-03
mar-04
dec-02
-5
may-03
0
Source: Statistics Sweden
As was previously discussed, the focus of Swedish households on pension savings
contributes to the low level of deposit funding. In all likelihood, this focus is a contributing
factor to the difficulty in influencing household deposit volumes. In the case of pension
savings, the focus is on long-term returns, and in the current low interest rate environment, short-term interest savings would not be particularly attractive. In conclusion, it
21
is probably very difficult for the banks to change the availability of deposit funding. It is
also likely that the limited expansion of the deposit base that could be possible would
be largely unstable, since it would most likely come from investors who are more active
in their behaviour and are likely to withdraw their funds quickly if creditworthiness, interest rates or other conditions change. It could thus contribute to reducing stability in the
banking sector by increasing the liquidity risk.
In summary, a number of advantages are associated with not solely prioritising
deposits as a source of funding. A diversified funding base creates an opportunity to
minimise funding costs and reduces dependence on individual products or markets.
As long as the alternative borrowing is primarily long-term, and cash flows in and out of
the bank are matched, bond funding means that the liquidity risk in the bank is significantly lower than with pure deposit funding.
Does foreign funding entail higher liquidity risk for Swedish banks?
Against the backdrop of the actions of Swedish institutional investors as discussed
above, Swedish banks have a natural need to borrow abroad. Does this need entail
an increase in liquidity risk for the bank? The reason generally put forth that this
should be the case is that foreign lenders have a greater tendency to withdraw their
funding if the creditworthiness of the Swedish banks comes into question. The extent
to which such a risk is significant is strongly dependent on how the foreign funding
is used, and is mainly due to whether or not the bank takes on liquidity risk in the
foreign currency. For Handelsbanken, this has been a decisive argument for matching short-term funding in foreign currencies with short-term liquid assets (mainly sight
deposits with central banks).
When assessing liquidity risk it is crucial to differentiate between short-term and
long-term foreign funding. The major problem arises if the bank funds illiquid assets
in the foreign currency with short-term borrowing in foreign currency. If this foreign
funding were withdrawn, the bank would be at risk of a liquidity shortage in the foreign
currency. This risk has been at the focus of current discussions in Sweden about the
Riksbank’s potential to provide liquidity assistance in foreign currency: partly in the
inquiry on the Riksbank’s financial independence and balance sheet (SOU 2013:9), and
partly in conjunction with the Riksbank decision in December 2012 to expand its foreign
exchange reserve. For Handelsbanken, it is crucial to use short-term foreign funding
to finance either liquid assets in the same currency or short-term Swedish assets. If
the foreign funding were withdrawn for any reason, the Bank could use the liquidity
reserve, realise liquid assets or increase funding denominated in Swedish kronor. As
discussed above, the portion of short-term borrowings related to funding currency
hedging for Swedish institutional investors hardly entails any liquidity risk for the Bank.
If currency hedging is impossible on a particular occasion, the currency swap is not
renewed by the Bank and the institution has a surplus of Swedish kronor, which needs
to be invested in some form.
22
Meanwhile, it is difficult to see any way that long-term borrowing in foreign currency
could be associated with increased liquidity risk for the Bank. Long-term borrowing
is probably the best way for a bank to fund illiquid assets as lending. Of course some
refinancing risk exists because long-term bonds also have to be refinanced, but this is
limited because the Bank holds considerable liquidity reserves and a balanced maturity
profile in its bond borrowing. By having substantial reserves, a bank can refrain from all
market borrowing for a long period of time. Moreover, it should be preferable for a bank
to avoid overusing the Swedish market when foreign funding is available. By not overusing Swedish market borrowing, the Bank would have more scope to increase issues
if a crisis were to arise and foreign markets become more difficult to access.
In conclusion, when assessing whether foreign funding provides a bank with liquidity risk that is difficult to manage, it is important to view such funding in relation to how
the foreign currency is used. If the foreign funding is matched with foreign assets that
have the same or shorter maturity as the funding, the bank does not take on added
liquidity risk. If the foreign currency is swapped for domestic currency, the impact on
liquidity risk depends on the liquidity situation for the bank in the domestic currency,
and consequently, is a question for the bank’s total liquidity situation. The foreign
funding adds nothing different from the domestic funding in this regard. Only if the
bank uses the foreign funding for illiquid assets in the foreign currency does a separate
foreign liquidity risk arise. For Handelsbanken it is important not to do this, but to always
ensure that the Bank can handle a situation in which foreign funding is completely
withdrawn, without a liquidity shortage in the foreign currency arising.
Socio-economic perspectives on banks’ funding
An analysis of Swedish banks’ funding and how it relates to other participants in
the Swedish economy shows that the relatively low percentage of deposit funding
in Swedish banks and the use of foreign market borrowing are both a result of the
institutional conditions under which savers, investors and banks act. If these conditions
entailed socio-economic problems or costs, there would be reason to take active measures to try to change this funding structure. The potential socio-economic problem put
forth in some cases is that the funding structure carries an increased liquidity risk for
banks, which increases the risk of a banking crisis. The last section questioned whether
the existing funding model actually increases the liquidity risk for banks and argued instead that the current funding structure reduces liquidity risks for banks. However, the
banks’ funding structure also affects how the economy works beyond the direct effects
on the banks, as discussed below. If it were the case that there were other adverse
effects, there could just as well be reason to actively try to change the way that banks
obtain funding.
23
Does the economy need a higher level of deposit funding?
As a starting point, it should be noted that there are more theoretical reasons that
diverse borrowing adds socio-economic value. Deposits as a form of savings provide
the saver with two separate benefits. The saver receives a return on the investment
in the form of interest. And the deposit is liquid, which means that saver can use the
funds at any time. Different savers may value these benefits differently; one saver
may prioritise returns, while another may value liquidity. Usually someone who wants
to lend money requires a higher interest rate if the money is to be lent for a long time,
in part because the risk that the money would not be repaid increases over time,
and in part because the lender wants a premium for not being able to use the money
during the relevant time period. Consequently short-term interest rates under normal
circumstances are lower than long-term, or expressed differently, the yield curve has
a positive slope.
Since traditional deposits are available at any time, interest rates on these accounts are governed by short-term interest rates, and thus by definition they become
less attractive for a saver who prioritises returns over liquidity. As discussed above,
the pension focus of Swedish saving is one reason why deposits as a proportion of
household saving are low in Sweden. One possibility for the return-oriented saver is
to deposit their money for a fixed term, which would provide long-term interest on the
investment. Fixed-term savings have not been popular in Sweden, but are common in
many other countries. One drawback for savers in these cases, however, is that they
give up liquidity in order to achieve a higher return. Thus there is a built-in trade-off
between liquidity (or maturity) and return.
Securities borrowing has a major advantage in this regard because it separates
liquidity and return. For savers who want high returns, but are not quite willing to give
up the ability to cash in their investment, it is much more attractive to buy bonds than
to save in deposit accounts, regardless of whether or not it is fixed-term. Bond investments are not particularly accessible for most households and less active investors,
but fixed income funds of various types address the distribution problems of small
savers.
By separating liquidity and return potential, securities borrowing adds value to the
wider investor community. From this perspective, it should be viewed as positive that
banks offer savers a wider range of investment opportunities, rather than just trying to
attract money through deposits.
In a market economy, the normal starting point is to allow market forces to determine
which products should be produced and consumed, and the prices at which this occurs.
The market for capital can be viewed in the same way. One of the most important “interventions” in this market is that deposits can be viewed as a government-subsidised
product because of the deposit guarantee. The banks pay for this subsidy through the
fee charged for guaranteed funds. Consequently, deposits already have a strong priority as a product, compared with other types of savings.
24
The deposit guarantee is probably one of the most important reasons that deposits
are currently considered to be a stable source of funding. When depositors have the
government as their guarantor they do not need to take account of the risk in the investment, because the government bears the risk if the bank goes under. The deposit
guarantee scheme has been broadened in recent years, in both size and the number
of deposit institutions covered, so the government bears an increasingly large risk of
problems among the guaranteed deposit institutions. As the depositors do not need
to take account of the risk at the bank thanks to the guarantee, the monitoring function that a financier normally has over the parties it lends to disappears. This market
disciplinary effect exists in the bond market in a totally different way. Since the government takes on a higher risk through guarantees for deposits, and the market disciplinary effect disappears, it is strange that governments and supervisory authorities also
often recommend increased deposit funding. There are plenty of examples in history
of crises (such as the US Savings & Loans crisis) that were caused by competition for
government-guaranteed deposits forcing an increase in deposit interest rates. As a
result, the banks had to increase the risk in their assets to receive sufficient return. This
ultimately led to the banks that had taken the largest risks going under, and the government having to foot the bill due to the deposit guarantee scheme. The government
should therefore also be interested in seeing balanced use of deposit funding.
Rather, the issues discussed here suggest that deposit funding should hardly be
further promoted by the government. It is also difficult to find any other positive
socio-economic aspects that would favour such encouragement.
Socio-economic aspects of foreign funding
The imbalance between Swedish investors’ demand for investments in Swedish banks
and the banks’ need to finance lending to Swedish industries results in a shortage of
domestic funding on the order of SEK 1,500 bilion (see figure 2) 9 to achieve a balance
between supply and demand for Swedish funding. Since Swedish banks borrow this
money abroad and lend this money to Swedish households and companies, these
Swedish banks add a large volume of foreign capital to the Swedish real economy.
As a comparison, this amount is about equal to the value of foreign ownership on the
Stockholm Stock Exchange and it amounts to 60 per cent of the stock of foreign direct
investments in Sweden.
Tremendous socio-economic benefits are associated with investors in an economy
having access to capital for their investments, since investment activity is one of the
primary driving forces behind economic growth. Most governments, and the Swedish
government is no exception, devote considerable resources to attracting foreign capital
9 This figure is based on figure 2. It is by no means precise and in many respects is based on how various
sectors are defined and measured. It should therefore be viewed as a rough indication of the magnitude of
the funding requirement. It also coincides with the volume of bond borrowing by Swedish banks in foreign
currencies.
25
and removing obstacles for its inflow to the domestic economy.
Moreover, the banks’ foreign funding generates value for institutional investors
who use the banks to hedge their foreign currency investments. As was previously
discussed, this swap activity enables the institutions to broaden their investments and
hold more foreign assets than would otherwise be possible. If the banks were unable
to finance these swaps with foreign borrowing, the possibility for this currency risk
management would be considerably more complicated.
These socio-economic advantages have not been fully discussed in the context in
which banks’ foreign borrowing has been discussed. The discussion in recent times
has mainly involved the Riksbank’s ability to act as “lender of last resort”; i.e., the
Riksbank’s crisis management task of injecting liquidity into the banking system in a
system-threatening situation, where funding cannot be obtained from other participants. For the Riksbank, liquidity risk in foreign currencies is a particularly important
issue with respect to this duty. In its capacity as guarantor for the Swedish krona, the
Riksbank can essentially furnish unlimited liquidity denominated in Swedish kronor.
However, the ability to act as “lender of last resort” in other currencies can in some
cases be limited, which the Riksbank has called attention to after the crisis of recent
years. This relationship underlies the Riksbank’s decision in December 2012 to expand
the foreign exchange reserve, with the purpose of strengthening the Riksbank’s ability
to provide liquidity in foreign currencies to Swedish banks in critical situations. The
question has also been the object of the above-mentioned inquiry by Professor Harry
Flam (SOU 2013:9).
The Riksbank has discussed in various contexts that the banks should somehow
bear the cost for the Riksbank to be prepared to provide liquidity denominated in
foreign currency. One proposal with this focus was also submitted in Professor Flam’s
inquiry, which proposed that banks’ foreign borrowing should be covered by a
fee-based insurance, in order to cover the Riksbank’s expenses for maintaining a foreign
exchange reserve that can be used for liquidity assistance in foreign currencies.
The logic of both the Riksbank and the inquiry is based on the fact that banks’
foreign borrowing only provides increased risks for the Swedish banking system. The
advantages discussed here have not been stressed. Moreover, regarding the concept
discussed above, Furthermore, it can be questioned to what extent foreign funding
really adds liquidity risk in foreign currency. If Swedish banks manage their foreign funding without specifically taking on liquidity risk in foreign currency by having a matched
currency position, in principle the Riksbank would not need a separate capacity to
provide liquidity assistance in foreign currency. Any need for liquidity assistance for
Swedish banks arising in such cases would be denominated in Swedish kronor, not in
a foreign currency. Of course it is not easy for the Riksbank to monitor whether the
banks manage their liquidity in such a way, since different banks may act differently
and behaviour can change over time. The Riksbank can therefore not be expected to
completely ignore a potential need to provide liquidity assistance in foreign currencies.
26
However, these conditions should affect the evaluation of a possible fee-based funding
of the costs incurred by the Riksbank to be prepared to provide liquidity assistance in
foreign currencies, and also the assessment of the size of the need for assistance.
First of all, it can be discussed whether there is need to charge a separate fee for
foreign funding at all. Foreign funding is not just associated with socio-economic costs
in the form of increased risks for the banking system; it is also associated with substantial socio-economic benefits. Weighing these costs and benefits against each other is
no simple task, but considering that the banks already pay substantial fees in the form
of stability and deposit guarantee fees, it is not at all clear that foreign funding really does
entail an increased net cost for society that may justify an additional separate fee.
Secondly, if fee-based funding were implemented it would be important to structure
it so that it does not provide bad incentives for the banks’ funding. For example, it should
not include long-term bond funding, since this only entails advantages for both the banks’
liquidity risk and the national economy at large. Nor should it have a negative impact on
short-term foreign funding used to support currency risk management for institutional
investors to the extent that it does not add liquidity risk in foreign currency. Finally,
it should not have a negative impact on funding used to build up the banks’ liquidity
reserve in the foreign currency. It is therefore reasonable that only funding that actually
entails a currency risk in a foreign currency should be considered for fees. Professor
Flam’s inquiry does not have a complete proposal for fee-based funding, but appears
to some extent to be pursuing a similar argument since the investigation writes that the
fee should reflect “which risk the bank takes on for each unit of foreign currency” 10. It is
hardly simple to design such a system, but considering the advantages associated with
foreign funding, it is important that the beneficial foreign funding should not be rendered
complicated or more expensive. And this difficulty must be taken into account when
considering whether there is reason to introduce a separate charge at all.
In summary it is dubious whether it would be appropriate to try to restrict or increase the cost of Swedish banks’ foreign funding. If such measures were nevertheless implemented, in practice it would mean an attempt to limit the supply of foreign
capital to Sweden while – for good reason – there are no restrictions on Swedish savings moving abroad. The result would be a distortion where the opportunities to bring foreign capital to the Swedish economy would be made more difficult, compared with the
conditions for Swedish capital to support foreign economies. Sweden is a small open
economy with its own currency, which has benefited in many ways from internationalisation, the growth of free trade and the free flow of capital across borders. These
trends have helped to make Sweden one of the world’s best performing economies,
which has managed very well in the current turbulent phase of the global economy. It
would be a pity to impair the conditions that made this achievement possible by curbing
Swedish banks’ funding abroad.
10SOU 2013:9 page 114.
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