Erik Thedéen: Rules prevent crises

Finansinspektionen is responsible for macroprudential policy in Sweden, which includes both promoting financial stability and counteracting financial imbalances. We are also tasked with promoting a high level of consumer protection on the financial markets. One of the reasons that we have been given the responsibility for macroprudential policy is that financial crises have proven themselves to be very expensive.

Date: 08/02/2018

Speaker: Director General Erik Thedéen

Location: Affärsvärlden Bank & Finans 2018, Birger Jarl Konferens, Stockholm

Since the most recent financial crisis, international work has focused on capital and liquidity requirements in the banking sector. These requirements aim to increase the resilience within the banking sector, but often have rather limited effects on lending to households and corporates. This is why we have implemented and tightened the amortisation requirement. The amortisation requirement has resulted in households buying less expensive homes and borrowing less. But household debt is still rising rapidly. Why?

The Swedish economy currently finds itself in a unique situation with high growth, maximized resource utilisation and low interest rates. Together with a housing market that is not fully function, this has resulted in the rapid increase in debt. Lending to households have increased faster than household disposable income the past few years. The rate at which household debt is rising is expected to slow, but it will still rise faster than disposable income, despite the slow-down we have witnessed on the housing market in the past six years. Mortgages are increasing, as are consumption loans, and lending to corporates has recently begun to increase as well. It is only the public section of the Swedish economy that is not borrowing more.

In this rich lending environment, the financial sector is also growing. New participants are entering the market, and profitability is good in general. Despite our capital requirements, the major Swedish banks are reporting high return on equity, well above the European average. Cost-efficiency is high. Since 2014, five authorisations for banking operations have been granted. The number of credit market companies has also increased, and we furthermore have set records on the stock exchanges in Sweden for the past three consecutive years for the number of IPOs. Old business models are being challenged by innovation and new companies.

When I meet colleagues from other countries, innovation and its impact are at the top of the agenda. Sweden is in the forefront. When we describe Swedish consumers' everyday financial routines, it seems like utopia in some areas of the world. There are many other places where innovation is strong, for example in London, but if we compare the development of these services among the entire population, they cannot even come close to what we are experiencing in Sweden. Ten years ago, many of the services revolved around different payment methods. Today, the focus is more on digitalisation of the financial market in general - from both new and established companies. This has an impact on almost all regulations.

Given this background and the assignment we have received from the Government, we are establishing an Innovation Center. Companies may need a dialogue guidance in matters where the regulations are considered unclear. We also take the position that dialogue can provide us with a better understanding of and insight into how our regulations affect innovations, and that we can become more knowledgeable earlier in the development phase in order to more efficiently safeguard the financial system and protect consumers.

In many countries, so-called "regulatory sandboxes" have been established to kick-start innovation on the market. Sweden is already strong in innovation. We do not want to change this. Introducing a regulatory sandbox might introduce limitations on the market in that companies may perceive it as being necessary to be in the sandbox to test innovation. We would also not prefer to select a few companies that will receive different treatment than those outside the sandbox. The Innovation Center will enable us to strengthen the conditions for testing financial innovations through a more open dialogue with the companies.

It is important that the digital development does not introduce risks to stability and consumer protection. Financial innovation also means risks, which is another reason why we need to be proactive. Unfortunately, all innovation is not good innovation. All products and services are not necessarily good. Many make things easier for consumers, but the participants on the market need to take responsibility and ensure that consumers are able to understand the consequences of their own decisions. Some of the areas where there may be major risks are, for example, cryptocurrencies and ICOs. Many of these are subject to heavy speculation, and there are even incidents of fraudulent behaviour.

I would also like to comment on the feedback regarding the Government's proposal to give FI a greater regulatory mandate within credit risk. FI currently does not have authorisation to issue regulations about what constitutes good credit risk management. The extended regulatory mandate offers FI the possibility to also issue regulations regarding credit assessments and loans to related parties.

Lending is a central part of a credit institution's business, and the credit assessment is its core. Regulations that regulate credit risk management but do not contain rules about credit assessment run the risk of being ineffective. In its supervision, FI has observed deficiencies in credit risk management, including in some institutions' credit assessments and management of loans to related parties. FI also has received international feedback from ESRB and IMF that the existing regulations are insufficient.

Many relevant viewpoints have been raised in conjunction with the external consultation of FI's proposed regulations. These will be considered in the continued regulatory work.

One viewpoint that has been raised is that the proposed extended authorisation good lead to much too detailed regulations. The intention of the proposed regulations, however, is not to micro-regulate, but rather to give credit institutions the possibility to design and adapt their credit risk management based on their operations.

Feedback was also raised that the proposed regulations could cause a credit crunch. FI would therefore like to emphasise that the sections regulating credit assessment are not placing stricter demands on the borrower's repayment capacity than the current regulation already does. However, the proposal does clarify the requirements placed on the credit institutions' internal credit procedures and requires that the credit institutions have good control over their risks. These are natural features of sound banking operations.

If I may say a few closing words. Sweden is currently experiencing unique economic conditions. Together with a housing market that is not fully functional, this has led to higher debt for both households and businesses. The rate of innovation in the financial industry is high. To date the rising levels of debt have not caused major problems, so why does FI need to introduce regulation?

Our macroprudential measures are often driven by systemic risks or externalities. Systemic risks means risks that could harm the entire financial system, for example because the financial system is closely interlinked. By demanding that banks maintain capital buffers for this systemic risk reduces the risk of contagion effects, which could create a financial crisis.

Externalities are when third parties could be affected. Household debt is one example. When a large number of households hold large loans, they may be forced to sharply reduce their consumption in the next economic downturn. This will increase unemployment, which enhances the downturn. And when many households become unemployed and reduce their consumption, the knock-on effect can be credit losses in other sectors in the economy, which by extension can threaten financial stability. But the possibility of other households becoming unemployed or the emergence of credit losses in other sectors are not taken into consideration by the household or the bank when the loan is granted. This is why we have implemented a mortgage cap and an amortisation requirement.

We naturally will never know exactly what will cause the next crisis. That is why we are taking measures to raise resilience among both the banks and their customers. And I take the position that now, when all of the curves are pointing upward, now is the best time to start building this resistance. To just wait and see can also come at a price.