Additional capital requirements for Nordea's PD estimates

FI noted during the spring that Nordea's reported Probability of Default (PD) as a percentage of its corporate lending was larger than its estimated PD during certain years and in certain markets. In other words, actual PD was higher than the bank's estimated PD.

Because the PD estimate serves as a basis for the bank's capital requirements, this means that there is a risk that Nordea's capital requirements may be too low. In an initial internal analysis, it was noted that the capital deficiency could potentially be as large as SEK 50-80 billion. The conclusion drawn from this analysis was that the matter must be analysed in more detail, and FI opened an investigation in April. The investigation has not been concluded yet; to date FI has only sent a first verification letter to the bank outlining FI's preliminary assessments.

The regulations governing the banks' internal models state that banks shall estimate PD values using long-term averages. This means that the number of actual defaults during limited periods could exceed the PD estimates without constituting a breach of the regulations. An assessment of whether the PD estimates are too low requires a broad analysis that includes, for example, an assessment of the economic development of various markets. FI has now conducted such an analysis.

Within the framework of the annual Supervisory Review and Evaluation Process (SREP), which FI is obligated by law to conduct every year for the major banks, FI makes an assessment of the banks' total capital needs. The result of this year's SREP was sent to Nordea the 30th of September.

In this year's SREP, FI and the closely affiliated supervisory authorities that are members of Nordea's supervisory college (Finanstilsynet Denmark, Finanstilsynet Norway, Finansinspektionen Finland and the European Central Bank) have made the assessment that Nordea's PD estimate needs to be raised to an extent that corresponds to an additional own funds requirement of SEK 13.8 billion (EUR 1.47 billion), of which SEK 11.0 billion shall consist of CET Tier 1 capital.
As a basis for its assessment, FI requested and compiled new data from Nordea and arranged meetings between FI's and the bank's model experts. The closely affiliated authorities in Nordea's supervisory college were given the data compiled by FI. They were also kept informed about FI's analyses and given the opportunity to comment on the analyses. FI's responsible model experts presented their assessment on 5 September for Director General Erik Thedéen, who approved the assessment as it was presented by the model experts. The closely affiliated authorities in Nordea's supervisory college met on 15 September to discuss the assessments made in this year's SREP prior to reaching a joint decision, which has now been passed.

The assessment of the capital deficiency is based on a broad analysis of updated and more detailed information, which was obtained from Nordea, and the outcome of which was broken down by country and exposure class. There are several reasons why the final capital deficiency was determined to be much lower than what was indicated in the internal memorandum that initiated the ongoing investigation. One of the primary reasons is that the initial analysis made the assumption that Swedish economic conditions were representative for all of Nordea's exposures to corporates, even though a significant portion of Nordea's operations are outside of Sweden.

Until Nordea rectifies the identified deficiencies in its internal models, the bank must provide additional capital corresponding to the above amount as part of its Pillar II capital requirements. When determining the size of the additional capital requirement, consideration was also given to the memorandum published by FI in May specifying that banks must base their PD estimates on historic outcomes where at least every fifth year is considered a "downturn year" (FI's supervision of banks' calculations of risk weights for exposures to corporates, FI Ref. 15-13020).

FI will publish the capital requirements for the ten largest banks on 25 November 2016.