Swedish banks: Tips from an ageing model; Where banks are both safe and profitable

Swedish banks: Tips from an ageing model; Where banks are both safe and profitable

Sep 28th 2013 |From the print edition

ASK almost any banker in New York or London whether banks can have strong capital ratios and still generate mouthwatering returns for shareholders, and they will probably think you a fool. A doubling of the capital a bank has will, all else being equal, halve the bank’s return on equity (ROE). For most bankers there is an uneasy tension between making banks safer and making them attractive investments. Developments in Sweden, however, suggest it is possible to have both safety and profitability.On September 24th Sweden sold its remaining 7% stake in Nordea, Scandinavia’s biggest bank, a legacy of the country’s 1990s banking crisis. That crisis—in which Swedish authorities swiftly wrote down bad assets, moved them into a “bad bank” and recapitalised the remaining “good bank”—informed many of the bail-outs in the 2008 financial crisis.

Since then Sweden has again taken a lead on regulation. It has imposed some of the highest capital ratios in the rich world, with minimum levels of core tier-1 capital (the best sort) set at 12% from 2015, compared with a minimum of 7% by 2019 under Basel 3. In late August it proposed to ratchet capital levels yet higher, with plans to add up to 2.5% to the capital ratio as a counter-cyclical buffer. It has also interpreted risk-weightings far more strictly than many peers. It has tripled the amount of equity that banks have to use to fund mortgages; it may tighten further. Yet even these punitive levels of capital seem easily within reach. Many of the country’s biggest banks already have capital ratios of about 12% under the new rules (and close to 15% under the old Basel 2 regime).

You might think such stiff regulation would lead to weak earnings. In fact Sweden’s banks have been earning respectable profits, are able to pay dividends and have seen their share prices soar. Nordea’s shares were up by 28% this year, just before the government sold its last stake. Those of smaller rivals such as Swedbank and SEB are also up by 20-25%.

Swedish banks are generating among the highest returns on equity among rich-world banks. Number-crunchers at Citigroup reckon that the big Swedish lenders will be generating returns of about 15% over the next few years. That compares with forecast returns of 10-12% at other European banks such as Deutsche Bank, Barclays and Société Générale.

One reason for the strong profitability of Swedish banks is their careful control of costs. “Australian and Nordic banks are the most cost-efficient…in the world,” Citi’s bank analysts wrote in a recent report, citing among other factors their use of technology to get customers to bank digitally instead of using branches. They are also helped by the fact that they operate in a bit of an oligopoly and can thus pay measly rates on deposits.

Yet their high capital ratios may also play a role. Credit-default-swap spreads for Sweden’s big banks, a measure of default risk, are significantly lower than for many of their peers, suggesting that their borrowing costs are much lower, too. The solidity of their balance-sheets seems to have proved attractive to investors who may still be wary of buying bank stocks.

As much as Sweden offers a hopeful example that banks can be safe and profitable, it also offers a warning of how long it can take for governments to extricate themselves from crisis-era shareholdings. Sweden’s final exit from Nordea has taken two decades. Governments across Europe hoping for quick sales of their nationalised banks should take note.