FI wants tightening of models, but not standard risk weights

Dec 4th, 2015

Swedish banks must tighten the internal models used to calculate their risk weightings and capital requirements, the Swedish FSA said, but it and Swedish bankers warned that standardised risk weights, as are foreseen under so-called Basel IV, could increase risks in the banking sector.

FinansinspektionenIn a financial stability report published on Tuesday, the Swedish FSA (Finansinspektionen, or FI) said that Swedish banks have “to some extent” worked on risk-weight minimising, taking advantage of a weaknesses in regulation on internal models to minimise their requirements.

The report cited as an example that average risk weights for company exposures have declined from around 60% to just over 30% since 2007.

“This is due to a large extent the banks improving their risk management but also a consequence of risk-weight minimisation,” the FSA said. “FI therefore considers that the regulations for internal models should be tightened.”

FI said a tightening of regulation will eventually be achieved by international agreements and European regulation, noting that the Basel Committee has begun such a process, and said it is investigating how it can quickly improve management of model risks and deal with weaknesses in the construction of internal models.

But while proposing a tightening of the rules, FI said that capital requirements should remain risk-weighted.

“If they are well-designed, risk-sensitive capital requirements give a more accurate picture of a bank’s capital needs,” it said. “Moreover, they create strong incentives for healthy risk taking and good control of the measuring, reporting and management of risks in the balance sheet.”

In a response to FI’s financial stability report, the Swedish Bankers’ Association (Svenska Bankföreningen) on Tuesday said internal models are an important tool for sound lending, adding that since they began to be used banks have strengthened their ability to assess and price risks.

“The FSA and Swedish banks have a common interest in internal models being used in a responsible manner,” said Hans Lindberg, CEO of the Swedish Bankers’ Association. “To the extent that FSA sees deficiencies in the regulations or the application we are of course open to further dialogue on these issues.”

It is expected that proposals for future Basel regulation will include a standardised approach to risk weights.

FI said that a standardised floor could lead to Swedish banks’ capital adequacy ratios having a weaker link to the risk they take on when lending because the banks have a low risk profile, meaning that on average they have lower risk weights calculated with internal models than foreign banks.

“This can ultimately lead to the financial system becoming less stable as banks are encouraged into more risky lending as it is less profitable to hold assets with lower risk and return,” it said.

The Swedish Bankers’ Association agreed that a return to standard-based risk-weighting and binding requirements on the leverage ratio would increase rather than decrease risks in the banking system.

“We have a common interest in safeguarding the well-functioning Swedish system,” added Lindberg. “It benefits the Swedish economy at large.”

FI said Swedish banks are currently well capitalised, noting that the requirements made of Swedish banks are twice as high as the EU minimum requirements, and that in June FI decided to raise the countercyclical buffer from 1% to 1.5%, to further strengthen the banks’ capital position. It said that as a whole the Swedish financial system is functioning efficiently and has satisfactory resilience.

It added, however, that indebtedness of Swedish households is high and rapidly growing, representing a vulnerability that could lead to increased economic instability. In March, FI proposed measures aimed at lowering risks linked to highly-leveraged households, including a requirement that new mortgages be amortised down to a LTV ratio of 50%. The introduction of the measures was delayed by a dispute with the Swedish parliament, which was resolved in September.

“This means that the requirement can be in force in summer 2016,” FI said, “which will probably contribute to a calmer development on the housing market and dampen growth in indebtedness.”

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