Swedish FSA, Debt Office dispute Riksbank covered bond stance

Nov 27th, 2015

Sweden’s FSA and National Debt Office have questioned the rationale behind proposals from the Riksbank that would tighten its rules on the use of covered bonds as repo collateral, and disputed that certain structural risks and vulnerabilities are not reflected in covered bonds’ ratings.Riksbank imageThe Swedish Bankers’ Association also questioned the stance of the Riksbank, after the central bank on 21 October proposed four amendments to its criteria for repo collateral that are aimed at increasing diversification of the collateral pledged to the central bank and at reducing the credit risk therein. The proposed amendments are:

That covered bonds issued by the counterparty itself shall no longer be accepted as collateral for credit at the Riksbank. This is a return to the terms and conditions for collateral that applied before the global financial crisis hit the financial system in 2007.

The requirement for the lowest credit rating for securities to be accepted as collateral to be raised from the current A-to AA-.

The introduction of a concentration-limit rule under which covered bonds, as a share of a counterparty’s total collateral value, may amount to a maximum of 60%.

The introduction of a concentration-limit rule under which a maximum of 50% of the share of a counterparty’s collateral value that comprises covered bonds may consist of covered bonds from the same issuer.

In a joint letter published on Friday of last week (20 November), the Swedish FSA (Finansinspektionen, or FI) and the Swedish National Debt Office (Riksgälden) criticised the proposals and said they must be investigated further and discussed in the Financial Stability Council.

An analyst at SEB said the letter questioned the motives behind the Riksbank’s proposals more than the content of the proposals themselves.

“The FSA and the debt office are not against changing the rules,” she said. “But they think that if the Riksbank tries to force banks to hold less covered bonds and more government bonds in the interest of financial stability then that is something that must be discussed in the Stability Board.”

The Riksbank noted in its proposals that Swedish covered bonds currently receive the highest possible ratings, but said it believes there are certain structural risks and vulnerabilities associated with covered bonds that are not reflected in the ratings.

According to the SEB analyst, the FSA and the debt office do not share the Riksbank’s view on this matter and they do not think the Riksbank explains clearly enough how it comes to this conclusion.

The Swedish Bankers’ Association (Svenska Bankföreningen) also published a response to the Riksbank proposals, in which it shared the concerns of the FSA and debt office, and said the proposals had concerned investors and market participants.

“The important thing to note is that there is a lack of research behind the Riksbank’s opinion,” said Jonny Sylvén, senior advisor at the Swedish Bankers’ Association. “We can’t understand why they have changed their view on the instrument.”

“If they think that saying negative things about covered bonds will have an impact on the indebtedness of households, then that is very farfetched.”

The Swedish Bankers’ Association also disputed that certain structural risks and vulnerabilities are not reflected in covered bonds’ ratings.

“Rating agencies can of course be wrong,” said Sylvén, “but they have a method that considers systemic risk in the banking sector.”

When explaining its proposals, the Riksbank said the extent to which Swedish banks rely on covered bonds in their liquidity reserves is unsatisfactory, noting that covered bonds compose almost two-thirds of major banks’ liquid securities denominated in Swedish kronor, while round 70% of the total collateral pledged to the Riksbank consists of covered bonds.

It said that if a large proportion of these bonds are owned by a small number of banks, there is a risk that the bonds will be difficult to sell in a crisis, and that this “cross-ownership” of covered bonds also gives rise to spillover effects within the banking system if banks need to sell others’ covered bonds to secure liquidity. It added that access to wholesale funding at low interest rates, including covered bonds, has also contributed to a considerable increase in Swedish householders’ indebtedness in the last 10 years.

The Riksbank proposed that the amended terms and conditions would be introduced in stages in 2016, with the timeframe to be announced at a later date.

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