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Do Swedish banks’ liquidity risks threaten financial stability?

The major Swedish banks’ liquidity risks should be reduced in order to ensure financial stability, states the Riksbank in a new report. For some time, the Riksbank has been concerned that the major Swedish banks take substantial structural liquidity risks due to the mismatches between the maturities of the banks’ assets and the maturities of their liabilities. This, together with the size and concentration of the Swedish banking system, makes it vulnerable compared to European counterparts.

The Executive Board of the Riksbank has tasked Kasper Roszbach, Head of the
Financial Stability Department, to look over the banks’ structural liquidity risks and analyse how these risks could be reduced. The findings in the report “The major Swedish banks’structural liquidity risks” discusses how a market for covered bonds with longer maturities could be created.

The average remaining maturity of Swedish covered bonds is around 3 years, which is considerably shorter than the maturity of the mortgages they fund. Moreover, only about 10 percent of the major Swedish banks’ outstanding issued securities have a maturity in excess of 5 years, which is very low in a European perspective. The major Swedish banks’ structural liquidity risks are also relatively large in relation to those of other European banks.

Pehr Wissén, PhD and Senior Adviser at the Swedish House of Finance, has contributed to the report with an analysis of the major Swedish banks’ mortgage business and the available alternatives with regard to extending the maturity of the banks’ covered bonds.

“My view differs from the one of the Riksbank”, he says. ”I look at the problem from the point of view of the individual bank whereas the Central bank – for obvious reasons – take a systemic perspective.”

The Riksbank argues that the problem should be tackled by altering the banks behavior, i.e. to make banks emit bonds with longer maturity, Pehr Wissén argues that one should begin in the other end. To strengthen long term financial stability, it is the behavior of the mortgage takers that needs to be changed.

”The banks are simply providing the financial product their clients demand.”

People tend to live in their houses for several years, but chose short term interest-rate fixation periods on their mortgages because it is cheaper compared to long term interest-rate fixation. Also, the construction of the mortgage contract gives the households an incentive to choose short interest fixation periods.

”This makes households sensitive to changes in interest rates. If households go for longer interest-rate fixation periods, this would minimize their sensitivity to interest rates and provide more financial stability on the whole”, says Pehr Wissén and continues:

”There may be reasons to seek ways of giving households an incentive to choose longer interest-rate fixation periods for their loans. If they did this, it is likely that the banks would follow and choose to refinance their mortgages with longer-term borrowing.”