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Sweden’s Banking Model Offers Lessons for Europe

Institutions are thriving despite having to meet tough capital standards because of reforms adopted after previous crises. Nordea's Christian Clausen says risk management is key.

Peter Einarsson’s title is branch manager, but he acts like a CEO.

Einarsson enjoys a degree of autonomy almost unheard-of for a man in his position, running the Svenska Handelsbanken branch in the heart of Stockholm’s financial district as if it were his own business. He doesn’t worry about concentration risk and has broad leeway from senior management to grant loans quickly without approval from higher-ups. “I decide how we should function in the market covered by this branch — whether we should focus more on corporate or retail clients,” he explains.

On the walls of the branch’s 1905 beaux arts building, huge paintings in heavy frames depict cargo-laden ships in Stockholm’s harbor. Financing such commerce was Handelsbanken’s main business for most of its 142-year history, but these days mortgages account for two thirds of the branch’s balance sheet and occupy 25 of its 32 employees. “We don’t think about our exposure to particular business sectors,” Einarsson says. “We just ask ourselves, ‘Where are the opportunities in this neighborhood?’”

That confident attitude is a hallmark of the Swedish banking system, whose robust health stands in sharp contrast to much of the 18-nation euro zone. “Whenever we go abroad, people sound envious about our banking system,” says Peter Norman, Sweden’s minister for financial markets, sitting relaxed and tieless on a recent dress-down Friday at his office in a boxy glass building a stone’s throw from the harbor.

More than five years after the global financial crisis erupted in full force, euro zone banks are still struggling to clean up their balance sheets and regain a semblance of normal lending. European Union regulators and bankers would do well to cast a glance at Sweden, where the country’s Big Four banks are enjoying record profits even as they meet some of the toughest regulatory capital standards in the developed world.

Nordea Bank, the largest Nordic lender, uses its extensive mobile and Internet banking network to slice costs and increase profits while net interest rate margins shrink. Swedbank, which underwent a near-death experience five years ago because of steep losses in the Baltic countries, now has so much excess capital that it pays out three quarters of its profits in dividends. Skandinaviska Enskilda Banken (SEB) boasts an active controlling shareholder — the fabled Wallenberg family — that allows it to pursue long-term strategies without fretting over day-to-day stock price movements. Handelsbanken has outperformed the European banking market for three decades and never needed taxpayer assistance or a rights issue during the global financial crisis.

It wasn’t ever thus. The banking sector owes much of its strength today to a devastating financial crisis that shook the country in the early 1990s. Back then the bursting of a housing bubble and a run on the krona triggered a financial meltdown every bit as severe for Sweden as the 2008 panic was for the U.S. and Western Europe, prompting the government to provide a massive bailout and deposit guarantees to keep the sector afloat.

Crucially, regulators forced the banks to carry out painful reforms that steeled them for weathering future storms. The banks shrank their balance sheets — by 50 percent or more in some cases — and simplified their businesses by focusing on loans and fees while abandoning proprietary trading. They also embraced cost-cutting technology, becoming some of the earliest pioneers of online banking. Most of all, they embraced the notion that carefully managing risk is the key to delivering sustainable returns.

“Swedish banks developed a credit risk culture that would be hard for other European banks to replicate,” says Nick Anderson, a London-based analyst for Berenberg Bank. No surprise, then, that Swedish banks have the lowest nonperforming-loan ratio among industrial countries: a minuscule 0.3 percent, according to a recent Citigroup research report. By comparison, fully 9.2 percent of Italian bank loans are nonperforming, while French and German banks have NPL ratios of 5.2 percent and 2.5 percent, respectively.

“Boringly beautiful” is the way Ronit Ghose, a London-based analyst who coauthored the Citigroup report, describes Swedish banks. “They have no global domination plans, just a business mix of mostly plain-vanilla retail and commercial banking,” he says. “But this boring strategy is attractive to investors because these banks manage to generate high capital returns even in a very tough regulatory environment.”

Credit also must be given to a succession of governments over the past two decades that have set the macroeconomic table for the banks. “This is not the same old Sweden that many people abroad still talk about,” says Jacob Wallenberg, chairman of Investor, the nation’s largest holding company. Indeed, Sweden certainly isn’t the profligate nanny state that Tea Party Republicans warn the U.S. threatens to become.

Sweden pared public spending from a peak of 67 percent of gross domestic product in 1993 down to 49 percent in the first half of 2013 — less than France (53 percent) and on a par with Italy. The government ran a budget surplus of 2.3 percent of GDP in the first nine months of 2013, compared with an estimated 3.1 percent deficit for the euro area in 2013 and 4.1 percent for the U.S. in the fiscal year ended September 30.

“The political will to keep the state from falling into serious deficit has been very important for the banks,” says Ulf Riese, chief financial officer at Handelsbanken. And that political will is expected to survive even if, as polls predict, a center-left coalition led by the Social Democrats defeats the center-right government headed by the Moderate Party in elections scheduled for September 2014.

To be sure, Swedish banking isn’t fail-safe. Both Swedbank and SEB were nearly overwhelmed by the 2008–’09 crisis in neighboring Estonia, Latvia and Lithuania and had to raise capital. “Our banks learned their lessons from the early 1990s in Sweden but somehow forgot them when they crossed the Baltic,” says Johanna Lybeck Lilja, state secretary for financial markets.

These days regulators worry mainly about two intertwined issues: the large ratio of banking assets to GDP and the high indebtedness of Swedish households, particularly mortgage debt.

With a banking sector four times larger than the country’s $540 billion economy and with the Big Four banks accounting for 70 percent of domestic deposits, “too big to fail” resonates in Sweden. Meanwhile, household borrowing levels reached 170 percent of disposable income at the end of 2012, among the highest in Europe. (The Netherlands was at 285 percent, the U.K. at 150 percent, Germany at 88 percent and the U.S. at 81 percent.) “As a regulator, I always worry about something,” says Martin Andersson, director general of the Swedish Financial Supervisory Authority (FSA), who puts rising mortgage volumes at the top of his list. “They account for a very significant portion of the balance sheets in all four big banks.”

Analysts at Standard & Poor’s estimate that strong increases in Swedish house prices have left homes 25 percent overvalued relative to household incomes. “You have a shortage of housing, a low-­interest-rate environment, and banks are willing to increase household lending partly because corporate investment has slowed,” says Sean Cotten, an S&P analyst based in Stockholm.

To cope with an overgrown financial sector and swelling household debt, Swedish regulators have imposed some of the toughest capital requirements in the world. The Basel III global accord calls for banks to hold core tier-1 capital of 7 percent of risk-weighted assets by 2019, but the Swedes demand that their banks reach 12 percent by 2015; additional measures, such as a countercyclical capital buffer and an increase in risk weights for mortgages, will raise the effective capital requirement past 15 percent. The banks are taking those requirements in stride, though: At the end of September, their core tier-1 capital ratios ranged from 14.4 percent at Nordea to 18.8 percent at Handelsbanken.

“All those regulatory measures have been good,” says Nordea CEO Christian Clausen. He contends that his bank could be profitable even with a capital ratio of 25 percent.

Created from a smorgasbord of Swedish, Danish, Norwegian and Finnish banks between 1997 and 2000, Nordea is today the 13th-largest EU bank, with €677 billion ($920 billion) in assets. Some analysts don’t like Nordea’s multiplicity of markets, particularly its strong presence in Denmark, which has struggled to recover from a burst housing bubble since the global financial crisis, and Finland, where high-tech Nokia Corp. and the paper manufacturing industry are floundering. “If you are pan-Nordic, you have exposure to everything that is good — basically, Sweden and Norway — but also to everything that is bad, meaning Denmark and Finland,” says Andreas Håkansson, a Stockholm-based analyst for Exane BNP Paribas. “An investor probably would prefer to cherry-pick the good parts.” The 39.5 percent rise in Nordea’s share price in 2013 lagged the 53.5 percent gain at SEB, which is more focused on the domestic market. Handelsbanken’s stock increased 36 percent.

Clausen begs to differ with Håkansson, pointing to the investor enthusiasm that greeted the September 25 sale of the Swedish government’s 7.1 percent stake in Nordea — a legacy of the 1991–’92 crisis that placed the bank and several other lenders under temporary state ownership. The government raised 21.6 billion Swedish kronor ($3.4 billion) from the share sale, one of the largest European stock market transactions in 2013. Clausen views Nordea’s multiple footprints across the Nordic region as simply good risk management. “If you stick to one country, when things go bad, they can get catastrophic,” he says, noting that his bank’s lower exposure in the Baltics left it far less damaged than Swedbank and SEB during the 2008–’09 crisis there. Nordea avoids concentration in its €340.4 billion loan portfolio. Its largest single exposure is to real estate (12.5 percent). Sweden accounts for one third of its lending, with Denmark, Finland and Norway almost equally splitting most of the rest.

Tight cost control and a decline in retail loan losses have kept profits buoyant. Net income jumped 19 percent in 2012, to €3.13 billion, and was up 4 percent in the first nine months of 2013, to €2.34 billion. The bank achieved those results despite increased capital requirements and an economic slowdown that saw Sweden’s GDP grow at a sluggish 1 percent pace in 2012 and 2013, compared with increases of 6.3 percent in 2010 and 2.9 percent in 2011.

“Because of all the deleveraging going on in the world,” Clausen says, he doesn’t expect much growth in Sweden or the other Nordic countries, except oil-rich Norway, over the next few years. Yet he insists that cost-cutting and technology will continue to deliver profits and paybacks for Nordea’s shareholders.

Operating expenses were steady at €5.2 billion in 2011 and 2012 and ran at a similar rate in 2013. The bank kept a lid on costs by reducing staffing from 33,068 employees in 2011 to 29,403 last year. The biggest drivers behind these economizing moves: Internet and, especially, mobile banking. “It took our Internet banking about 18 years to reach its current level,” says Clausen. “And it has been overtaken by our mobile banking, which started only 18 months ago.” In the third quarter of 2013, the bank’s Swedish customers used mobile devices to log into their accounts 34.6 million times, compared with 27 million log-ins using computers.

Mobile banking is especially popular among Swedes under the age of 40. They make store purchases by scanning product bar codes with their smartphones and then swiping their phones over payment terminals. They transfer money directly and in real time to other accounts simply by dialing up their phone numbers. “Young people don’t even consider going into a bank unless they are facing an important money decision,” Clausen says. A case in point is the CEO’s 22-year-old son, who recently moved into his first apartment. “He could have taken out his mortgage over the phone but decided it was time to finally deal with a banker in person,” says Clausen.

Domestic mortgages and expansion in the Nordic region and the U.K. are the hot banking topics at Handelsbanken, the third-largest Swedish bank, with assets of Skr2.4 trillion and net income that rose 10 percent in the first nine months of 2013, to Skr10.77 billion.

Once synonymous with corporate lending, Handelsbanken devoted Skr829 billion, or 49.3 percent of its total loan portfolio, to mortgages as of the end of September, giving it a leading 35 percent share of the Swedish market. The bank is also emphasizing foreign growth, particularly in the U.K., where it sees the economic rebound outpacing that of the euro area. “We are targeting the top of the income pyramid in the U.K.,” says CFO Riese.

Regulators do worry about the growing exposure of Swedish banks to household debt: In 2010 they declared that mortgages could not exceed 85 percent of the value of a property. They are now debating whether to reduce the loan-to-value ceiling to 75 percent. In May regulators tripled the risk weight on mortgages, to 15 percent — slightly above the level for the largest European banks, according to FSA director Andersson. “We are trying to attack the growth of household debt on several fronts, and we are starting to see it flatten out,” he says.

Swedbank, which devotes half of its Skr1.2 trillion loan portfolio to mortgages, estimates that the higher risk weights will require it to boost capital by an additional 1.5 percentage points, yet it plans to increase mortgage lending. “We are more confident about the market than we were three or four years ago,” CFO Göran Bronner says. “This is our No. 1 business area, so we want to keep our footprint.”But worries about housing values persist. In December, Standard & Poor’s warned that easy mortgage availability had led to a 25 percent overvaluation of the Swedish housing market. Bankers insist record prices are a result of a housing shortage, especially in the Stockholm area, and not a product of low interest rates.

The banks have an impressive arsenal to reduce credit risks among their retail clients, starting with credit checks that might stir privacy fears in other markets. Anybody who rents a car in Sweden is subject to an instant check by a centralized credit bureau that has full access to the client’s financial records, including bank accounts, any previous loans and missed payments, personal income tax declarations for the previous five years and any queries made about the client by other credit institutions in the preceding 12 months. “For a bank this is fantastic. It means the risk of a loan default in Sweden is much lower than in any other country,” says Dag Detter, a co-founder of Whetstone Solutions, a Stockholm-based consulting firm to banks.

Handelsbanken uses other strategies to achieve Sweden’s lowest NPL ratio: a practically invisible 0.08 percent in 2012. The bank doesn’t offer incentives or bonuses to loan officers, CFO Riese says, “because it encourages the wrong kind of behavior in lending.” And eight out of ten mortgage clients amortize their loans every year — about twice the ratio for Swedish banks as a whole. The country’s regulations don’t require that borrowers pay down the principal on their loans every year, and since the early 2000s most banks have not pressed mortgage holders to amortize their loans regularly. As a result, mortgage holders today service their loans at a rate that would take 140 years, on average, to pay off their mortgages. “Handelsbanken has always been very good at avoiding bad stuff,” says Exane BNP Paribas analyst Håkansson.

Such risk aversion has long made the bank a favorite with investors. According to research by Berenberg, between 1982 and 2012 Handelsbanken’s share price outperformed that of the average European bank by almost 700 percentage points. The stock rose 36 percent in 2013, compared with a gain of 15.3 percent for banks in the Stoxx Europe 600 Banks index.

But in terms of investor sentiment, even Handelsbanken ranks behind Swedbank, the fourth-largest lender by assets. The bank, founded in 1820 as the country’s first savings institution, seems determined to hand back capital and dividends to its shareholders. Convinced that competition in its markets will continue to compress net interest margins and reduce revenue growth, Swedbank has focused on cost efficiency and higher return on equity, which reached 14.5 percent in the first half of 2013. “Improving our ROE has been more important than seeking volume growth that hasn’t materialized,” says CFO Bronner. The bank boasted ROE of 16.2 percent in the third quarter of 2013, ahead of rivals Handelsbanken (14.2 percent), SEB (13.4 percent) and Nordea (10.8 percent).

Swedbank already is paying out 75 percent of its profits in dividends, and management asserts it will exceed that payout ratio as soon as regulators reveal the ultimate capital levels they intend to impose on the banks. “Once we have an understanding of those terms and have the final rules in place, we will address that issue,” Bronner says.

The fact that Swedbank, with a core tier-1 ratio of 17.2 percent, is chomping at the bit to return more capital to shareholders speaks volumes about the bank’s transformation in recent years. For most of the postwar period, Swedbank was a humdrum mass-market retail bank and mortgage specialist that confined its business to Sweden. But with the collapse of the Soviet Union, the bank leaped into the new Baltic republics. It quickly emerged as the market leader in Estonia, Latvia and Lithuania, where credit was growing by more than 50 percent annually.

Swedish officials now concede they fell asleep at the wheel. “We have to face the fact that regulators stood by and let those banking markets increase without doing anything to slow them down,” says FSA director Andersson.

Financial experts, meanwhile, are concerned that today’s successes are breeding renewed complacency. “Both the banks and regulators have increased capital requirements far above the European average,” consultant Detter says. “But only time will tell if enough has been done to avert a future crisis.”

The Baltic credit bubble in housing and other consumer spending burst in 2008. Over the next two years, the collective economies of the three Baltic nations shrank by 20 percent and wages shriveled by as much as 30 percent. At the trough of the crisis, in 2009, Swedbank was rocked by Skr10.5 billion in losses. It needed two capital rights issues, totaling Skr27.4 billion, to survive.

Today, Swedbank’s Baltic operations are a much smaller part of the bank’s overall balance sheet than they were four years ago. Though Swedbank’s total assets rose modestly to Skr1.83 trillion at the end of September 2013 from Skr1.81 trillion at the end of 2008, its Baltic assets fell by half over that period, to Skr117 billion. “We have learned our lessons,” says Birgitte Bonnesen, who heads Swedbank’s Baltic banking operations from Riga, Latvia.

The bank prices risk in the Baltics with as much care as it takes in Sweden. Also, technology-driven cost efficiencies have been put in place. Today 30 percent of all transactions in the Baltics are done through mobile and Internet banking. Half of Swedbank’s branches are mainly self-service, with skeletal staffs that help clients operate the ATMs and Internet banking terminals and set up computer chats with specialists.

Credit checks are rigorous for any sizable purchase. “If you are in Riga on a Saturday morning looking over a new washing machine and the store tells you it can finance the sale, you have to check with us by mobile banking, and we will give you a yes or no response immediately,” Bonnesen says.

Such innovations helped Swedbank boost net profits by 6.5 percent in the first nine months of 2013, to Skr11.58 billion. Technology has also allowed the bank to reduce costs: Swedbank had slashed its payroll to 14,500 at the end of September from 21,000 in 2008. But steep personnel cuts, along with the rapid introduction of mobile and Internet banking products and software that clients found too complex, have led to complaints. “There is more grumbling that there are too few employees at the local branch,” says Berenberg’s Anderson, citing recent opinion surveys.

“The banking sector, including Swedbank, struggles with declining customer satisfaction levels,” conceded Swedbank CEO Michael Wolf at a third-quarter-results news conference in October. Although the bank doesn’t intend to increase branch staff, it has promised to simplify its mobile services to make it easier to access accounts, transfer funds and make payments.

Payouts, meanwhile, have kept shareholders happy. “During the worst of the Baltic crisis, Swedbank was hated by everybody,” says Christer Gardell, managing partner and co-founder of Cevian Capital, one of Sweden’s leading hedge fund firms, which sold its 3.58 percent stake in Swedbank two years ago. “And now it’s the most loved bank in Europe — maybe even in the world.” The share price performance bears him out. Since mid-2010, Swedbank’s stock has outperformed that of the average European bank by 275 percentage points, according to Berenberg research. The stock rose 42.5 percent in 2013.

One unique advantage the Big Four Swedish banks enjoy over their euro zone peers is a tradition of major stakeholders that are willing to back longer-term management strategies. “They are also expected to take charge in a crisis,” Gardell says. “In fact, they would be criticized if they didn’t.”

All the banks have active owner-­shareholders. Nordea’s chairman, Björn Wahlroos, is also chairman of Sampo, the Finnish insurer that holds a 21.4 percent stake in the bank. Handelsbanken chairman Anders Nyrén is CEO of Industrivärden, a large Swedish holding company with a 10.3 percent stake in the bank. Swedish insurer Folksam holds a 9.22 percent stake in Swedbank and has named its former CEO Anders Sündstrom as the bank chairman.

None of these shareholders carries as much clout as the Wallenbergs and their holding company, Investor, do at SEB, Sweden’s second-largest bank, with Skr2.6 trillion in assets. The Wallenbergs have been active players longer than anybody else: In 1856 their ancestor André Oscar Wallenberg, a descendant of farmers and Lutheran clergy, founded Stockholms Enskilda Banken, which eventually grew into SEB, and he invested the bank’s earnings in a range of industrial companies, some of which are still controlled by family.

When most investors talk about the long term, they typically mean more than three years, says Investor chairman Jacob Wallenberg. “What we mean is 50 years,” he adds. “We buy to hold, not to sell.”

Investor owns 4 to 40 percent stakes in 11 major companies, including industrial equipment manufacturers Atlas Copco and ABB, telecommunications business Ericsson, pharmaceuticals concern AstraZeneca, home appliance maker Electrolux and global stock exchange operator Nasdaq OMX Group. Each company and its competitors are covered by Investor analysts, whose reports circulate exclusively in-house. “So when I go to a board meeting, I am hopefully well informed and received as a very relevant participant at the table,” Wallenberg says. “In addition, from time to time I will call the CEO of a company and ask what’s going on and whether something I have read or heard about is true.”

Investor owns a 20.9 percent stake in SEB, where Jacob’s cousin Marcus Wallenberg is chairman. Under CEO Annika Falkengren, the bank started to reduce its Baltic exposure in 2007 because of growing concerns over a credit bubble in the three former Soviet republics.

“We were already showing caution before the crisis began,” Wallenberg says. “But it was an extremely difficult situation because nobody had a clue where the Baltics were going.” As SEB’s share price tumbled from a precrisis high of Skr120 to a March 2009 trough of Skr20, the Wallenbergs reassured Falkengren and her executives. Jacob Wallenberg recalls dispensing advice along these lines: “Hey guys, we trust you, so relax. Sometimes stock markets don’t tell the whole story. Just focus on your job, and we will stand by you.”

It was tougher to persuade other major shareholders not to jump ship and instead back an Skr15 billion rights issue by SEB in March 2009. As the lead shareholder, Investor underwrote Skr3.5 billion. “If you can get across that you are a long-term anchor shareholder, the other investors and management will know that you won’t walk away from the problem, no matter how serious,” Wallenberg says. The stakeholders agreed to subscribe for 11 new shares for every five shares they owned — at a 40 percent discount. The bank’s fortunes turned around, with net profits rising to Skr6.8 billion in 2010 from only Skr1.2 billion in 2009.

SEB remains more of a corporate bank than its peers, with 45 percent of its Skr13.1 billion in operating profits during the first nine months of 2013 coming from merchant banking and retail banking accounting for only 20 percent. “It’s also the only Nordic bank that generates less than half of its revenue from net interest income, which is good in the current environment of slow volume growth,” says Exane BNP Paribas analyst Håkansson.

Net profits rose 26 percent in the first nine months of 2013, to Skr10.6 billion. At the bank’s third-quarter earnings conference in October, CEO Falkengren attributed the jump largely to a surge in earnings by Nordic corporate clients. “As an advisory- and activity-driven bank, SEB benefits from a more positive corporate sentiment,” she said.

But SEB lags in cost-cutting. It ended 2012 with a cost-to-income ratio of 59 percent, well behind Swedbank (45.7 percent), Handelsbanken (47.6 percent) and Nordea (50.6 percent).

SEB is also at the low end of the Big Four when it comes to dividend distribution, with a payout equivalent to 40 percent of profits. However, the bank insists it is on course to meet its 2015 target of 15 percent return on equity; ROE stood at 13.4 percent in the first nine months of 2013. That implies a higher capital payout for shareholders, Håkansson says.

Swedish regulators haven’t objected to the Big Four’s ever-higher payouts. “We don’t have any opinion on the payout rates as long as their capital levels are well above regulatory requirements and those expected in the future,” FSA director Andersson says.

And higher capital requirements are on the horizon. Officials at central bank Sveriges Riksbank and the Ministry of Finance are discussing the possible introduction of a capital levy linked to liquidity concerns, over and above Basel III’s liquidity ratio. Because Swedes prefer to keep their savings in mutual funds, the banks must get half of their funding from the wholesale market — and almost 50 percent of their wholesale funding is in foreign currencies.

The Riksbank has decided to increase its foreign reserves and make them available to the banks in case the currency markets dry up. “We believe that the increase in foreign currency reserves should be covered by the banks as an ‘insurance premium,’” says financial markets minister Norman. “Taxpayers should not have to pay for it.”

The big banks aren’t flinching at that prospect. Handelsbanken has undertaken an internal stress test, which it contends is more rigorous than those conducted by any European regulator, to measure the impact of a liquidity crisis. “If 20 percent of Handelsbanken’s deposits disappear and we have no access to the wholesale funding market to cover them, we could still run the bank without any extraordinary funding for close to two years,” CFO Riese says.

Executives at Swedbank have a bring-it-on attitude about additional requirements. “We have excess capital at this point in time,” says CFO Bronner. “We are just waiting for more clarity on what the regulators want us to have in terms of our total capital level.”

And just what capital levels do Swedish regulators consider safe for the banks? “That’s the Nobel Prize question,” says Norman. His colleague State Secretary Lybeck Lilja insists there is no reason for complacency at any capital level. “We shouldn’t fool ourselves — there will always be another crisis,” she says. “We just have to make it less probable and ensure it will be less serious when it happens.” • •

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