## _cr16355 - 2016. The FSAP findings were discussed with the

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### Mission composition and consultations
- Team members: Martin Čihák (mission chief), Liliana Schumacher (deputy mission chief), Jihad Al-Wazir, Atilla Arda, Jiaqian Chen, Eija Holttinen, Ivo Krznar, Martin Edmonds (all IMF staff); Michael Andrews, Timo Broszeit, Louise Carter, Francesco Columba, Jonathan Fiechter, Ian Tower (all external experts).
- Additional participants in concluding discussions: Craig Beaumont (mission chief for Sweden’s Article IV consultation) and Tomas Östros (IMF Executive Director).
- Contributors/presenters and support: Dale Gray; Rima Turk and Andy Jobst (analysis preparation); Rima Turk (IMF headquarters studies); Richard Lalonde, Jonathan Pampolina, and others.
- Stakeholder meetings: Riksbank, Finansinspektionen (FI), Ministry of Finance (MoF), National Debt Office (NDO); Parliament representatives; financial services companies; FMIs; research organizations; think-tanks; NGOs; officials from other countries in the region.

### Purpose, scope, and documentation
- FSAP assesses the stability of the financial system as a whole, not individual institutions.
- Objective: identify systemic risk sources and policies to enhance resilience to shocks and contagion.
- Exclusions: operational risk, legal risk, fraud-related risk.
- Sweden classified as having a systemically important financial sector; assessment part of bilateral surveillance under Article IV.
- Report prepared by Martin Čihák and Liliana Schumacher with inputs from the Sweden FSAP team and seven Technical Notes.
- Date: October 26, 2016.

### Executive-summary findings: systemic features and risks
- Systemic features:
  - Financial system assets about 5.5 times GDP.
  - Banking sector: more than two thirds of the financial system; one G-SIB and three banks designated by FI as Other Systemically Important Institutions; four banks account for over three-quarters of the Swedish banking market.
  - Insurance assets about 100 percent of GDP at end-2015; 88 percent in life insurance; over 300 insurance companies.
  - Capital markets: outstanding government and corporate bonds about 85 percent of GDP; stock market capitalization about 140 percent of GDP.
  - Covered bonds account for about 45 percent of bond market; government securities about 25 percent.
  - Foreign investors hold about one-quarter of outstanding Swedish bonds, equivalent to more than 20 percent of GDP.
  - Four critical domestic FMIs: RIX, BGC AB, NASDAQ Clearing, Euroclear Sweden.
- Key risks identified:
  - Macrofinancial risks have grown since 2011, notably rising share of highly indebted households.
  - Channel of concern: extreme but plausible scenario combining a decline in housing prices, loss of confidence in housing collateral, and amplification via banks’ wholesale funding reliance—potential sizeable indirect macroeconomic impact and cross-border spillovers across the Nordic-Baltic region.
- Follow-up since 2011: creation of the Financial Stability Council (FSC), increased FI resources, new resolution framework for credit institutions and investment firms.

### Resilience assessment and modeling concerns
- Stress tests indicate banks and nonbanks are largely resilient to solvency shocks.
- Concerns:
  - Banks’ models may overrely on recent historical experience and understate tail risks.
  - Models may not capture all second-round effects and non-linear scenarios.
- Recommendation: timely adoption of a leverage ratio as a backstop to guard against model and measurement errors in capital ratio calculations.

### Liquidity and funding vulnerabilities
- Loan-to-deposit ratio: about 200 percent (one of the highest in Europe).
- Customer deposits represent only about 40 percent of bank funding.
- Long-maturity residential mortgages rely on wholesale funding (covered bonds) with three-year average maturity.
- Structural liquidity gaps narrowed but remain more pronounced than European peers.
- Recommendation: monitor an extended (three-month) LCR in euro and U.S. dollar; closely monitor banks’ interconnectedness via the covered bond market.

### Data, stress testing, and sectoral coverage gaps
- Key data gaps: distributional data on household financial assets discontinued in Sweden; critical for systemic risk oversight.
- Recommendation: introduce comprehensive anonymized surveys of household balance sheets.
- Enhance stress testing frameworks for banks, insurance companies, and investment funds; FI to improve investment fund data availability and quality.
- Undertake periodic stress tests of corporate resilience.

### Policy recommendations (selected, with timing)
- Financial stability (priority labels: NT = near term, I = intermediate, MT = medium term, C = contingent)
  - Introduce a cap on the debt-to-income ratio (FI/MoF; ¶12) — NT.
  - Remove tax incentives to hold real estate assets and fund them with debt (MoF; ¶2) — NT.
  - Timely adoption of a leverage ratio as a backstop (FI; ¶24) — NT.
  - Monitor an extended (three-month) LCR in euro and U.S. dollar (FI; ¶27 and 46) — NT.
  - Introduce regular surveys on the distribution of household balance sheets (MoF; ¶40) — I.
  - Introduce regular stress tests of corporate resilience (FI; ¶14) — I.
  - Improve stress testing framework for banks and insurance companies (FI, RB; ¶23, ¶30) — I.
- Macroprudential policy and systemic liquidity oversight
  - Give FI a clear legal mandate for macroprudential policy and tools (MoF; ¶38) — I.
  - Give the FSC a statutory basis with power to issue recommendations and expand mandate to include crisis preparedness; establish preparatory groups for systemic risk monitoring and crisis preparedness (MoF; ¶39) — MT.
  - Amend the Riksbank Act to clarify RB’s role in financial stability and ELA authority; ensure RB’s strong financial position and protection from potential losses (MoF; ¶66) — MT.
  - Seek swap agreements with central banks in the Nordic countries, the Fed, and the ECB to strengthen ELA availability in relevant currencies (RB; ¶45 and ¶66) — NT.
- Regulation, supervision, crisis readiness, and resources
  - Broaden FI’s mandate to issue binding regulations on safety and soundness (MoF; ¶49) — MT.
  - Ensure occupational pensions receive same protection as life insurance (MoF; ¶50) — NT.
  - Improve investment fund data and FI’s stress testing ability for funds (FI; ¶33 and 55) — NT.
  - Enhance cross-border supervisory cooperation for systemic bank branches and cross-border fund management (FI; ¶34, ¶57, Box 1) — NT.
  - Under FSC, ensure agency-specific and national crisis preparedness: national crisis management plan, updated MoUs, regular simulation exercises (MoF/NDO/FI/RB; ¶65) — NT,C.
  - Revamp Nordic-Baltic Stability Group and update MoUs to strengthen crisis preparedness (MoF/NDO/FI/RB; ¶65) — NT,C.
  - Expedite resolution planning for systemic financial institutions (NDO; ¶64) — I.
  - Define strategies for liquidity assistance to banks in resolution and conclude solvency/viability cooperation agreement for institutions needing ELA (RB/NDO/FI; ¶65, ¶66) — I.
  - Increase financial and human resources for prudential supervision, recovery and resolution planning commensurate with Sweden’s financial sector size (MoF/FI/NDO; ¶40, ¶47, ¶48, ¶51, ¶52, ¶60, ¶64) — I.

### Macrofinancial setting: selected recent macro statistics
- Real GDP: 1.2 (2013), 2.6 (2014), 4.1 (2015), 3.4 (2016), 2.4 (2017), 2.2 (2018), 2.1 (2019).
- Unemployment rate (percent): 8.0 (2013), 7.9 (2014), 7.4 (2015), 6.9 (2016), 6.7 (2017), 6.7 (2018), 6.7 (2019).
- Household disposable income growth averaged about 3.5 percent per annum in 2012–2015.
- Public debt: 43 percent of GDP in 2015.
- Total revenues (percent of GDP): 50.9 (2013), 50.1 (2014), 49.1 (2015), 48.9 (2016), 48.9 (2017), 48.9 (2018), 48.7 (2019).
- Total expenditures (percent of GDP): 52.2 (2013), 51.7 (2014), 48.9 (2015), 49.1 (2016), 49.1 (2017), 49.1 (2018), 48.7 (2019).
- HICP inflation (e.o.p): 0.4 (2013), 0.3 (2014), 0.7 (2015), 1.2 (2016), 1.6 (2017), 2.0 (2018), 2.2 (2019).
- Output gap (percent of potential): -2.8 (2013), -2.2 (2014), -0.7 (2015), 0.9 (2016), 1.0 (2017), 0.7 (2018), 0.4 (2019).
- Current account (percent of GDP): 5.3 (2013), 4.6 (2014), 5.2 (2015), 4.9 (2016), 5.1 (2017), 5.0 (2018), 4.7 (2019).
- Net international investment position: -12.6 (2013), -0.3 (2014), 4.1 (2015), 6.0 (2016), 8.1 (2017), 10.1 (2018), 12.0 (2019).
- GDP per capita (2015, USD): 50,591.
- Population (2016, million): 9.9.

### Housing market vulnerabilities and recommendations
- Mortgage characteristics:
  - Mortgages granted before June 2016 lack mandatory amortization.
  - Typical contractual maturity: 30–50 years, with even longer maturities not unusual.
  - 70 percent of residential mortgages are based on floating rates.
- Household debt patterns:
  - Share of new mortgage borrowers with DTI above 450 (600) percent: about 37 (17) percent in 2015, up from 21 (10) percent in 2011.
  - Credit to households growing faster than disposable income; credit-to-GDP gap declined but remains positive.
- Prices and supply:
  - Price-to-income ratio is 40 percent above its 20-year average.
  - IMF Working Paper 15/276 suggests house prices are 12 percent above long-run equilibrium.
  - Pace of housing completions represents less than 1 percent of the housing stock.
- Scenario assessment:
  - A 20 percent house price decline could reduce GDP by 2.6 percent, with greater impact if coincident with a global downturn.
- Mission housing policy recommendations:
  - Introduce a cap on the DTI ratio to increase household resilience.
  - Give FI flexibility to calibrate LTV ratios.
  - Eliminate mortgage tax deductibility or revisit property tax ceilings.
  - Ease housing supply constraints by addressing land-use and planning restrictions.

### Corporate sector vulnerabilities and recommendations
- Corporate indicators:
  - Large corporates have strong interest coverage ratios, but strength declines with size.
  - About half of corporate debt is in foreign currency.
  - A 250 basis points shock to interest rates would bring interest coverage ratio of medium and small corporates to about 1.5.
  - Corporates represent about 30 percent of banks’ total exposures.
- Recommendation: implement regular top-down stress tests of corporate resilience and enhance supervisory focus on SME portfolios.

### Banking sector: capitalization, stress tests, and liquidity
- Capitalization metrics (select series):
  - Regulatory capital to risk-weighted assets: 12.6 (2010), 12.2 (2011), 12.5 (2012), 12.7 (2013), 12.4 (2014), 24.2 (2015).
    - Four major banks: 12.0 (2010), 11.5 (2011), 11.7 (2012), 12.0 (2013), 22.5 (2014), 24.2 (2015).
  - Regulatory Tier I capital to risk-weighted assets: 11.0 (2010), 11.3 (2011), 11.7 (2012), 12.0 (2013), 19.5 (2014), 21.1 (2015).
    - Four major banks: 10.4 (2010), 10.7 (2011), 11.1 (2012), 11.2 (2013), 19.4 (2014), 21.2 (2015).
  - Leverage ratio (capital as percent of assets): 4.8 (2010), 4.1 (2011), 4.4 (2012), 4.5 (2013), 5.0 (2014), 5.5 (2015).
  - Nonperforming loans to total gross loans: 1.9 (2010), 1.6 (2011), 1.5 (2012), 1.3 (2013).
  - Return on assets: 0.4 (2010), 0.5 (2011), 0.5 (2012), 0.6 (2013), 0.5 (2014), 0.6 (2015).
  - Return on equity: 9.8 (2010), 10.6 (2011), 11.4 (2012), 11.4 (2013), 10.2 (2014), 11.4 (2015).
  - Customer deposits as percent of total (non-interbank) loans: 47.8 (2010), 49.8 (2011), 52.9 (2012), 53.8 (2013), 56.5 (2014), 52.6 (2015).
  - Noninterbank loans to noninterbank deposits: 155.0 (2010), 153.8 (2011), 148.8 (2012), 145.9 (2013), 140.7 (2014), 152.4 (2015).
  - Foreign currency loans as percent of total loans: 36.5 (2010), 37.4 (2011), 34.9 (2012), 36.8 (2013), 39.4 (2014), 38.1 (2015).
  - Gross asset position in derivatives as percent of Tier 1 capital: 222.3 (2010), 351.2 (2011), 243.9 (2012).
- Risk weights and models:
  - Ratio of RWAs to total assets among the lowest in Europe due to IRB models applied to 96 percent of bank assets and low default rates.
  - Staff estimates show Swedish banks’ leverage ratios below European peers.
  - FI introduced risk-weight floors: 15 percent floor for mortgages in May 2013; raised to 25 percent in September 2014.
  - May 2016: supervisory approach for corporate internal models requiring at least every fifth year be treated as a downturn year; corporate risk weights expected to be at least around 30 percent.
- Stress testing framework:
  - TD and BU exercises covering largest four banks; two five-year scenarios: Baseline (IMF April 2016 WEO) and Stress (Sweden-specific L-shaped recession with more severe interest and exchange rate shocks than EBA).
- Key numeric elements of IMF stress scenario (2015–2020) — selected series (presented year-by-year):
  - Real GDP: 4078.6; 4050.0; 3912.2; 3798.9; 3874.3; 3943.7
  - Investment: 988.9; 984.8; 879.1; 819.9; 818.1; 827.9
  - Unemployment rate: 7.4; 8.2; 10.1; 12.6; 13.5; 13.5
  - HICP index: 100.7; 96.8; 96.5; 97.1; 97.7; 98.5
  - Real house prices (1981=100): 129.2; 109.0; 95.9; 92.0; 90.8; 94.6
  - Nominal house prices: 135.4; 109.4; 95.5; 92.1; 91.5; 96.1
  - Short term interest rate (percent): -0.2; -0.5; -0.5; -0.5; -0.4; 0.1
  - Long term interest rate (percent): 0.7; 2.4; 2.0; 1.9; 2.0; 2.5
  - 2-year covered bond yield (percent): 0.2; 1.5; 2.5; 3.0; 3.5; 3.9
  - 5-year covered bond yield (percent): 0.9; 2.3; 3.4; 4.0; 4.6; 4.9
  - Equity prices: 1562.5; 1165.1; 1210.3; 1415.8; 1550.8; 1682.4
  - KIX: 112.6; 115.6; 126.1; 124.0; 120.3; 113.8
  - Real GDP growth (percent changes): -0.7; -3.4; -2.9; 2.0; 1.8
  - Investment growth (percent changes): -0.4; -10.7; -6.7; -0.2; 1.2
  - Inflation (HICP) (percent changes): -3.9; -0.3; 0.6; 0.7; 0.8
  - Real house prices (yoy change) (percent): -15.6; -12.0; -4.1; -1.3; 4.2
  - Nominal house prices (yoy change) (percent): -19.2; -12.7; -3.5; -0.7; 5.0
  - Equity prices (yoy change) (percent): -25.4; 3.9; 17.0; 9.5; 8.5
  - KIX (yoy change) (percent): 2.7; 9.1; -1.6; -3.0; -5.4
- Stress test results and implications:
  - In the stress scenario, one bank would fall below the supervisory hurdle rate; no bank would breach the regulatory threshold.
  - Recapitalization to bring all banks to the supervisory hurdle rate would peak in 2018 at 2 percent of nominal GDP.
  - TD tests show larger losses than BU EBA estimates due to more severe interest and exchange rate shocks and larger projected credit losses.
  - Single factor shock: shutdown of foreign exchange swap markets (increasing RWAs) would entail higher capital needs.
- Policy implications:
  - Adopt leverage ratio as a backstop.
  - Promote sensitivity of bank models to tail risks and investigate drivers of risk-weight variability.
  - Strengthen liquidity monitoring and supervisory framework, including extended LCR for three-month horizon in USD and EUR.

### Investment funds: size, exposures, and redemption risk
- Total net assets of investment funds increased by 70 percent since end-2011, driven by equity and balanced funds.
- Premium Pension Authority represents 25 percent of total assets and mitigates some liquidity risks.
- Stress-test findings: corporate bonds markets most exposed to redemption shocks.
- Recommendation: develop continuous monitoring tools to assess sensitivity to extreme mutual fund redemptions and conduct liquidity risk analyses as funds grow/change investment structures.

### Interconnectedness across institutions and borders
- Swedish banks in Finland account for 70 percent of assets.
- Swedish banks account for 80, 70, and 55 percent of financial intermediation in Estonia, Lithuania, and Latvia respectively.
- Covered bond holdings as of end-2015:
  - Covered bond holdings equivalent to about 85 percent of banks’ equity.
  - Swedish banks held 28 percent of covered bonds outstanding in 2015.
- Recommendation: closely monitor banks’ cross-holdings of covered bonds; consider measures to contain contagion from correlated risks.
- Regional supervisory collaboration: strengthen Nordic-Baltic Macroprudential Forum; publish risk assessments and collect exposure data for network stress tests.

### FMIs, FX liquidity, and ELA
- FMIs well developed; overlap in supervision by FI and Riksbank—clarify coordination during crises and consider a joint crisis management plan.
- Riksbank can provide unlimited SEK liquidity; foreign currency injections require FX buffer.
- Swedish banks had short-term external debt equivalent to about 50 percent of GDP at end-2015; Nordea branchification could add further 25 percent of GDP.
- Recommendations:
  - Ensure appropriate FX buffers; seek swap agreements with Nordic central banks, the Fed, and the ECB.
  - Monitor extended LCR beyond the one-month ELA horizon, focusing on euro and U.S. dollar.

### Supervision resourcing and powers
- FI under-resourced: less than 100 staff to supervise 124 institutions, including one G-SIB.
- Legal constraint: FI may issue regulations only in areas specifically vested by law or ordinance—causing delays.
- Recommendation: give FI general power to issue binding regulations on safety and soundness issues and increase staffing/resources commensurate with system size and home-country responsibilities.

### Insurance sector: vulnerabilities and recommendations
- Low interest rates challenge life insurers: duration gap among highest in EU.
- Insurers increased equity allocations and reduced guarantees for new business.
- Stress test results:
  - A 500 bps increase in Swedish covered bond spreads could lead to a 7 percent reduction in own funds of the median company.
  - Sector appears well capitalized on aggregate but pockets of asset-side vulnerability exist.
- Recommendations:
  - Perform regular macroprudential stress tests complementing Solvency II Standard Formula and ORSA; incorporate multi-period perspective.
  - If Standard Formula inadequate, assess need for Pillar 2 capital add-on.
  - Resolve post-2019 regulatory uncertainties for occupational pensions; ensure same level of protection as life insurance.
  - Strengthen supervisory staffing and resourcing for high-impact entities; broaden consumer protection mandate and resources.

### Cross-border cooperation, crisis readiness, and Nordea branchification (Box 1)
- Nordea context:
  - Nordea assets about EUR 650 billion; assets equivalent to 140 percent of Sweden’s GDP.
  - Designated a G-SIB by the Financial Stability Board.
- Implications of converting subsidiaries to branches:
  - Majority of Nordea’s funding is wholesale; most balance sheet in currencies other than SEK.
  - Sweden would become home supervisor, primary central bank (Riksbank) for liquidity assistance, and primary deposit insurer.
  - Supervisory and fiscal contingent liabilities and resource needs would increase for Sweden.
- Recommendations:
  - Relevant supervisors, central banks, and ministries should negotiate agreements to address host-country concerns and support Sweden if it assumes additional responsibilities.
  - Riksbank suggested FI impose LCRs in Danish and Norwegian kronor on Nordea, obtain additional resources, and authority to implement macroprudential measures consistent with other countries.

### AML/CFT and financial integrity
- Progress since 2006: strengthened legal framework, national and sectoral risk assessments, national AML/CFT strategy.
- Shortcomings:
  - Low risk customers exempt from customer due diligence.
  - Beneficial ownership identification and verification need improvement.
  - Low quantity and quality of suspicious transaction reports in some sectors.
- Recommendations:
  - Improve understanding of ML/TF risks, enhance stakeholder cooperation, address customer due diligence exemption, establish beneficial ownership register via legislation, provide feedback to reporting entities.
- FATF assessment expected to finalize in 2017.

### Follow-up on 2011 FSAP recommendations (Appendix I) — summary of implementation status
- Institutional framework and crisis management: FSC established and operational; contingency planning enhanced but further steps needed.
- Prudential supervision/resources: FI appropriations increased from SEK 284 million in 2010 to SEK 491 million in 2016; more work needed on operational independence and resourcing.
- Market integrity, FMIs, and resolution: Nasdaq Clearing authorized under EMIR since March 2014 with governance and liquidity improvements; BRRD implemented in February 2016 with NDO as resolution authority; deposit insurance payout period shortened to 20 days.
- Data and monitoring: FI produces biannual stability reports and annual mortgage survey; household indebtedness closely monitored.
- AML/CFT: central beneficial ownership register planned under fourth AML directive; legislative work ongoing with expected in-force date by June 2017.

*Source: _cr16355 - 2016, October 26, 2016.*

### 2016. The FSAP findings were discussed with the

### _cr16355 - 2016. The FSAP findings were discussed with the

### Mission composition and consultations
- Team members: Martin Čihák (mission chief), Liliana Schumacher (deputy mission chief), Jihad Al-Wazir, Atilla Arda, Jiaqian Chen, Eija Holttinen, Ivo Krznar, Martin Edmonds (all IMF staff); Michael Andrews, Timo Broszeit, Louise Carter, Francesco Columba, Jonathan Fiechter, Ian Tower (all external experts).
- Additional participants in concluding discussions: Craig Beaumont (mission chief for Sweden’s Article IV consultation) and Tomas Östros (IMF Executive Director).
- Contributors/presenters and support: Dale Gray (part of mission), Rima Turk and Andy Jobst (analysis preparation), Rima Turk (IMF headquarters studies), Richard Lalonde, Jonathan Pampolina, and others (additional support).
- Stakeholder meetings: management and staff of Riksbank, Finansinspektionen, Ministry of Finance, National Debt Office; representatives of the Parliament; financial services companies; financial market infrastructure providers; research organizations; think-tanks; nongovernment organizations; officials from other countries in the region.

### Purpose, scope, and documentation
- The FSAP assesses the stability of the financial system as a whole and not that of individual institutions.
- The FSAP is intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion.
- Certain categories of risk are not covered: operational risk, legal risk, or risk related to fraud.
- Sweden is deemed by the Fund to have a systemically important financial sector; this stability assessment is part of bilateral surveillance under Article IV of the Fund’s Articles of Agreement.
- Report preparation: prepared by Martin Čihák and Liliana Schumacher, with inputs from the Sweden FSAP team members; draws on seven Technical Notes.
- Date: October 26, 2016.

### Executive-summary findings: systemic features and risks
- Sweden’s financial system is large and highly interconnected; relative to the size of the domestic economy, it is among Europe’s largest, with complex domestic and international linkages and Sweden’s role as a regional financial hub.
- Authorities’ follow-up since 2011: creation of the Financial Stability Council (FSC), increased resources at Finansinspektionen (FI), and a new resolution framework for credit institutions and investment firms.
- Macrofinancial risks have grown since 2011, notably a rising share of highly indebted households.
- Channel of concern: an extreme but plausible scenario combining a decline in housing prices, a broader loss of confidence in housing collateral, and amplification via Swedish banks’ reliance on wholesale funding—potentially generating sizeable indirect macroeconomic impact and cross-border spillovers across the Nordic-Baltic region.

### Resilience assessment and modeling concerns
- Stress tests suggest banks and nonbanks are largely resilient to solvency shocks.
- Concerns persist about banks’ models’ ability to capture unexpected losses; models may overrely on recent historical experience and understate tail risks.
- Recommendation: timely adoption of a leverage ratio as a backstop to safeguard against model and measurement errors in capital ratio calculations.

### Liquidity and funding vulnerabilities
- Banks’ structural liquidity gaps have narrowed but remain more pronounced than for European peers.
- Banks are reliant on wholesale funding and have significant maturity mismatches.
- Recommendation: monitor an extended (three-month) Liquidity Coverage Ratio (LCR) in euro and U.S. dollar; closely monitor banks’ interconnectedness through the covered bond market.

### Data, stress testing, and sectoral coverage gaps
- Key data gaps reduce systemic risk oversight effectiveness; critical missing element: distributional data on household financial assets (discontinued in Sweden but available in many other countries).
- Recommendation: introduce comprehensive anonymized surveys of household balance sheets for systemic risk monitoring.
- Authorities should enhance stress testing frameworks for banks, insurance companies, and investment funds; FI should improve availability and quality of investment fund data.
- Recommendation: undertake periodic stress tests of corporate resilience to better understand shock transmission to the broader economy.

### Policy recommendations (selected, with timing)
- Financial stability
  - Introduce a cap on the debt-to-income ratio (FI/MoF; ¶12) — NT.
  - Remove tax incentives to hold real estate assets and fund them with debt (MoF; ¶2) — NT.
  - Timely adoption of a leverage ratio as a backstop (FI; ¶24) — NT.
  - Monitor an extended (three-month) LCR in euro and U.S. dollar (FI; ¶27 and 46) — NT.
  - Introduce regular surveys on the distribution of household balance sheets (MoF; ¶40) — I.
  - Introduce regular stress tests of corporate resilience (FI; ¶14) — I.
  - Improve stress testing framework for banks and insurance companies (FI, RB; ¶23, ¶30) — I.
- Macroprudential policy and systemic liquidity oversight
  - Give FI a clear legal mandate for macroprudential policy, ensuring FI has tools to address systemic risks in a timely and effective manner (MoF; ¶38) — I.
  - Give the FSC a statutory basis with power to issue recommendations, preferably with a ‘comply or explain’ attribute; expand its mandate to include crisis preparedness; establish two preparatory groups: (i) systemic risk monitoring and (ii) crisis preparedness and management (MOF; ¶39) — MT.
  - Amend the Riksbank (RB) Act to clarify the RB’s role in financial stability, including confirming authority to extend liquidity assistance for financial stability purposes and ensuring RB’s strong financial position and protection from potential losses on such assistance (MoF; ¶66) — MT.
  - Seek swap agreements with central banks in the Nordic countries, the Fed, and the ECB to strengthen availability of ELA in relevant currencies (RB; ¶45 and ¶66) — NT.
- Regulation, supervision, crisis readiness, and resources
  - Broaden FI’s mandate to issue binding regulations on safety and soundness issues (MoF; ¶49) — MT.
  - Ensure occupational pensions receive the same level of protection as life insurance (MoF; ¶50) — NT.
  - Improve availability and quality of investment fund data and FI’s ability to conduct stress testing and other analyses for investment funds (FI; ¶33 and 55) — NT.
  - Enhance cross-border supervisory cooperation, including supervision of systemic bank branches and cross-border management of investment funds (FI; ¶34, ¶34, ¶57, Box 1) — NT.
  - Under FSC auspices, ensure agency-specific and national financial crisis preparedness, including a national crisis management plan, updated bi- and multilateral cooperation MoUs, and regular single- and multi-agency financial crisis simulation exercises (MoF/NDO/FI/RB; ¶65) — NT,C.
  - Revamp the Nordic-Baltic Stability Group, supported by updated bi- and multilateral MoUs, to strengthen crisis preparedness and management (MoF/NDO/FI/RB; ¶65) — NT,C.
  - Expedite resolution planning for systemic financial institutions (NDO; ¶64) — I.
  - Define strategies for liquidity assistance to banks in resolution and conclude a cooperation agreement for solvency and viability assessment of institutions that need ELA (RB/NDO/FI; ¶65, ¶66) — I.
  - Increase financial and human resources for prudential supervision, and recovery and resolution planning commensurate with Sweden’s financial sector size and home-country responsibilities (MoF/FI/NDO; ¶40, ¶47, ¶48, ¶51, ¶52, ¶60, ¶64) — I.

### Macrofinancial setting: key statistics and market structure
- Sweden’s financial system assets: about 5.5 times GDP.
- Banking sector: more than two thirds of the financial system; one G-SIB and three banks designated by FI as Other Systemically Important Institutions; four banks account for over three-quarters of the Swedish banking market and have extensive Nordic-Baltic reach.
- Insurance sector: total insurance assets about 100 percent of GDP at end-2015; 88 percent are in the life insurance sector; over 300 insurance companies (most small local firms); industry concentration is high.
- Capital markets: outstanding government and corporate bonds equivalent to about 85 percent of GDP; stock market capitalization about 140 percent of GDP.
- Bond market composition: covered bonds account for about 45 percent; government securities comprise an additional 25 percent; remainder mainly highly rated corporates and a growing portion of smaller and less highly rated issuers.
- Foreign holdings: foreign investors hold about one-quarter of outstanding Swedish bonds, equivalent to more than 20 percent of GDP.
- Financial Market Infrastructures (FMIs): four critical domestic FMIs—RIX (real-time gross settlement payments system, owned and operated by the Riksbank), Bankgirocentralen BGC AB (retail payments, cash withdrawals, card payments), NASDAQ Clearing (domestic central counterparty for exchange-traded and OTC IRD and repos), and Euroclear Sweden (domestic CSD and SSS for Swedish shares and fixed income). There are no trade repositories. Several FMIs located outside Sweden are relevant to the Swedish system.

*Source: _cr16355 - 2016, October 26, 2016.*

### 2.     Sweden’s oversight framework relies on three institutions and the Ministry of Finance. FI is

### 2.     Sweden’s oversight framework relies on three institutions and the Ministry of Finance. FI is

### Oversight framework and institutional roles
- FI is the single supervisor, with a mandate also for consumer protection and macroprudential issues.
- The central bank (Riksbank) is in charge of monetary policy, systemic liquidity, and payments oversight.
- The National Debt Office (NDO) acts as the resolution and deposit insurance authority.
- The Ministry of Finance (MoF) drafts financial legislation.
- Institutional status and budgetary arrangements:
  - The Riksbank is an independent authority under the Parliament.
  - FI and NDO are authorities under the government.
  - FI’s and NDO’s budgets are approved by the MoF.
  - The government proposes legislation to the Parliament, which allocates mandates and budgets to authorities such as FI.
  - Based on authorization by the government, FI issues secondary regulation.
- Ongoing reviews:
  - There are plans in the parliament to review the Riksbank Act.
  - The MoF is analyzing options to clarify FI’s macroprudential policy mandate.

### Financial Stability Council (FSC)
- Created in 2013.
- Chaired by the Ministry of Finance and comprises:
  - the Riksbank Governor,
  - FI Director General,
  - the NDO Director General.
- Role: forum for monitoring financial stability and discussing the need for measures to prevent financial imbalances and crisis management measures.
- Powers: It has no decision-making powers.

### Follow-up since 2011 FSAP
- Actions taken after 2011 recommendations:
  - Establishment of the FSC.
  - Increased FI’s resources.
  - Introduction of a new resolution framework for credit institutions and investment firms.
- Appendix I reviews the main steps taken since the last FSAP (reference noted in source).

### Recent macroeconomic developments (selected)
- Growth and employment:
  - Real GDP: 1.2 (2013), 2.6 (2014), 4.1 (2015), 3.4 (2016), 2.4 (2017), 2.2 (2018), 2.1 (2019).
  - Unemployment rate (in percent): 8.0 (2013), 7.9 (2014), 7.4 (2015), 6.9 (2016), 6.7 (2017), 6.7 (2018), 6.7 (2019).
  - Household disposable income growth averaged about 3.5 percent per annum in 2012–2015.
- Public finances:
  - Public debt: 43 percent of GDP in 2015 (described as low).
  - Total revenues (percent of GDP): 50.9 (2013), 50.1 (2014), 49.1 (2015), 48.9 (2016), 48.9 (2017), 48.9 (2018), 48.7 (2019).
  - Total expenditures (percent of GDP): 52.2 (2013), 51.7 (2014), 48.9 (2015), 49.1 (2016), 49.1 (2017), 49.1 (2018), 48.7 (2019).
- Inflation and output gap:
  - HICP inflation (e.o.p): 0.4 (2013), 0.3 (2014), 0.7 (2015), 1.2 (2016), 1.6 (2017), 2.0 (2018), 2.2 (2019).
  - Output gap (as a percent of potential): -2.8 (2013), -2.2 (2014), -0.7 (2015), 0.9 (2016), 1.0 (2017), 0.7 (2018), 0.4 (2019).
- Balance of payments:
  - Current account (percent of GDP): 5.3 (2013), 4.6 (2014), 5.2 (2015), 4.9 (2016), 5.1 (2017), 5.0 (2018), 4.7 (2019).
  - Net international investment position: -12.6 (2013), -0.3 (2014), 4.1 (2015), 6.0 (2016), 8.1 (2017), 10.1 (2018), 12.0 (2019).
- Other indicators and notes:
  - Data for 2016: various series specific to August/September/June/Q2 as footnoted in Table 2.
  - GDP per capita (2015, USD): 50,591.
  - Population (2016, million): 9.9.

### Risks and vulnerabilities in households’ and corporates’ balance sheets — A. The Housing Market
- Key features driving vulnerabilities:
  - The stock of mortgage loans granted before June 2016 does not have mandatory amortization.
  - Typical Swedish mortgage contractual maturity: 30–50 years, with even longer maturities not unusual.
  - In most countries, loans with no amortization requirements are considered high-risk and are subject to more restrictive lending standards.
- Household debt and borrowing patterns:
  - Rising household debt relative to income with new borrowers taking on increasingly high debts.
  - Share of new mortgage borrowers with debt-to-income (DTI) ratios above 450 (600) percent: about 37 (17) percent in 2015, up from 21 (10) percent in 2011.
  - The credit to GDP gap has declined but remains positive and credit to households is growing faster than disposable income.
  - 70 percent of residential mortgages are based on floating rates — households vulnerable to interest rate increases.
- House prices and incentives:
  - Price-to-income ratio is 40 percent above its 20-year average (described as among the highest in advanced economies).
  - IMF Working Paper 15/276 suggests house prices are 12 percent above long-run equilibrium.
  - House price gains provide incentives for households not to amortize loans and to take out larger loans relative to income, aided by longer maturities.
  - Mortgage interest rate deductibility and the lack of a property tax further propel house demand.
- Housing supply constraints:
  - Pace of housing completions represents less than 1 percent of the housing stock, lagging behind rising population, especially in urban areas.
  - Restrictions on land acquisition and planning procedures at the municipal level impair expansion of housing supply.
  - Rigidities associated with rental market controls exacerbate supply constraints.

### Assessment of house price fall scenarios and contagion risks
- Potential macroeconomic impact:
  - A 20 percent house price decline could reduce GDP by 2.6 percent, with a greater impact if it coincided with a global downturn.
- Transmission channels and amplifiers:
  - Direct effect on banks through nonperforming loans (NPLs).
  - Second-round effects from lower domestic demand affecting enterprises.
  - High interconnectedness within the Nordic-Baltic financial systems could transmit disturbances across the region if confidence in Swedish housing market collateral falls.
  - High reliance on wholesale funding and covered bond concentration in bank portfolios would act as an amplifier.
- Data and stress-testing limitations:
  - Stress tests may not capture all second-round effects.
  - No data on households’ wealth distribution comparable with distribution of debt burden for stress testing purposes.
  - Pre-crisis data suggest households with higher debt relative to income typically have lower liquid assets.

### Authorities’ view and supervisory approach
- FI’s assessment:
  - Rising house prices and high household debt do not necessarily entail high credit risk for banks because:
    - Swedish mortgages are full recourse loans.
    - Most households have high savings.
    - Social benefits are generally sufficient to limit defaults even in less financially secure households.
    - Loan origination includes stress tests of the adequacy of household buffers at high interest rates.
  - Supervisors are primarily concerned with the macroeconomic impact of household deleveraging (reduced consumption affecting employment and smaller firms).
  - FI’s stress tests on household level data for new mortgage originations align with this assessment.

### Macroprudential measures adopted since 2011 (Table 3)
- Measure — Implementation:
  - Maximum LTV ratio, 85 percent — October 2010
  - Risk-weight floor for mortgages, 15 percent — May 2013
  - LCR regulation, including in euro, U.S. dollar, and total — January 2014
  - Pillar II capital add-on 2 percent for the four largest banks — September 2014
  - Risk-weight floor for mortgages, 25 percent — September 2014
  - Systemic risk buffer 3 percent for four largest banks — January 2015
  - Counter-cyclical capital buffer activated at 1 percent — September 2015
  - Amortization requirement — June 2016
  - Counter-cyclical capital buffer raised to 1.5 percent — June 2016
  - Counter-cyclical capital buffer raised to 2.0 percent — March 2017
- Observations:
  - The 85 percent LTV cap adopted in 2010 has not contained indebtedness due to rising prices and possibility of taking uncollateralized loans above the cap.
  - The lack of mandatory amortization persisted until June 1, 2016, due in part to FI’s insufficient mandate.
  - The impact of recent macroprudential measures (including amortization requirement) is not yet clear.

### Mission recommendations on housing market policies
- Introduce a cap on the DTI ratio to increase household resilience and prevent higher housing prices from driving up household indebtedness.
  - Rationale: Although initially affecting a small portion of borrowers, a DTI cap becomes more binding as house prices rise relative to income and tends to lean against the cycle, unlike LTV limits.
  - International precedent: DTI caps were introduced in the United Kingdom and Ireland; under consideration in New Zealand and Norway.
- Give FI flexibility to calibrate LTV ratios.
  - Rationale: LTV limits directly reduce funding available to borrowers, hence can reduce housing demand and slow credit and house price growth.
- Eliminate mortgage tax deductibility or revisit property tax ceilings to moderate incentives to accumulate housing debt.
- Further ease housing supply constraints associated with excessively restrictive regulations in the use of land.

### Risks and vulnerabilities — B. The Nonfinancial Corporate Sector
- Corporate balance-sheet indicators and risks:
  - Large corporates appear to have strong interest coverage ratios, but strength declines with corporate size.
  - About half of corporate debt is denominated in foreign currency.
  - Banks usually do not require clients to have income in foreign currency as a condition for granting foreign currency loans.
  - A 250 basis points (bps) shock to interest rates would bring the interest coverage ratio of medium and small corporations to about 1.5; this would be aggravated if a recession reduced corporations’ earnings.
  - Corporate fragility is particularly important for banks with sizeable exposures to small and medium enterprises; corporates represent about 30 percent of banks’ total exposures.
- Mission recommendation for corporate sector monitoring:
  - Include corporate risks in FI’s risk analysis by implementing regular top-down stress tests of corporate resilience (similar to FI’s household assessments) to gauge the impact of macroeconomic instability on corporates’ ability to repay debt.
  - Enhance supervisory focus on small and medium enterprise portfolios, particularly for banks with concentrations in such exposures.

### Resilience of the financial system — A. Banks
- Profitability and drivers:
  - Banks have remained profitable in the negative rate environment.
  - High returns on equity primarily driven by low credit losses, low funding costs, and improved cost efficiency.
  - Net interest margin has been stable.
  - Large share of low-cost wholesale funding has partly mitigated the impact from the zero floor on retail deposit rates.
  - About 70 percent of mortgages have floating rate contracts, and banks re-price interest rates every three months.
- Selected financial soundness indicators (Table 5, select series):
  - Regulatory capital to risk-weighted assets: 12.6 (2010), 12.2 (2011), 12.5 (2012), 12.7 (2013), 12.4 (2014), 24.2 (2015).
    - Of which: Four major banks: 12.0 (2010), 11.5 (2011), 11.7 (2012), 12.0 (2013), 22.5 (2014), 24.2 (2015).
  - Regulatory Tier I capital to risk-weighted assets: 11.0 (2010), 11.3 (2011), 11.7 (2012), 12.0 (2013), 19.5 (2014), 21.1 (2015).
    - Of which: Four major banks: 10.4 (2010), 10.7 (2011), 11.1 (2012), 11.2 (2013), 19.4 (2014), 21.2 (2015).
  - Capital as percent of assets (leverage ratio): 4.8 (2010), 4.1 (2011), 4.4 (2012), 4.5 (2013), 5.0 (2014), 5.5 (2015).
  - Nonperforming loans to total gross loans: 1.9 (2010), 1.6 (2011), 1.5 (2012), 1.3 (2013).
    - Of which: Four major banks: 1.9 (2010), 1.5 (2011), 1.4 (2012), 1.2 (2013).
  - Return on assets (net income as percent of average total assets): 0.4 (2010), 0.5 (2011), 0.5 (2012), 0.6 (2013), 0.5 (2014), 0.6 (2015).
  - Return on equity (Net income as percent of average equity capital): 9.8 (2010), 10.6 (2011), 11.4 (2012), 11.4 (2013), 10.2 (2014), 11.4 (2015).
  - Liquid assets as percent of total assets: 4.8 (2010), 6.2 (2011), 8.5 (2012), 8.9 (2013).
  - Customer deposits as a percent of total (non-interbank) loans: 47.8 (2010), 49.8 (2011), 52.9 (2012), 53.8 (2013), 56.5 (2014), 52.6 (2015).
  - Noninterbank loans to noninterbank deposits: 155.0 (2010), 153.8 (2011), 148.8 (2012), 145.9 (2013), 140.7 (2014), 152.4 (2015).
  - Foreign currency loans as percent of total loans: 36.5 (2010), 37.4 (2011), 34.9 (2012), 36.8 (2013), 39.4 (2014), 38.1 (2015).
  - Gross asset position in derivatives as percent of Tier 1 capital: 222.3 (2010), 351.2 (2011), 243.9 (2012).
- Data notes:
  - From 2007 to 2013: based on Basel II with consideration to the Basel I-floor. From 2014: based on Basel III.
  - Four major banks data presented on a consolidated basis.
  - Non-consolidated data for distribution of monetary financial institutions’ credit; parent banks only; monetary financial institutions include banks and housing credit institutions.

*Source: IMF staff summary of the IMF document "Sweden" (extracted content unit)._

### 16.     Banks’ risk-weighted capital ratios are high, but risk weights are among the lowest in

### Banks’ risk-weighted capital ratios are high, but risk weights are among the lowest in Europe

### Banks’ capitalization and risk weights
- Large Swedish banks appear well capitalized by risk-weighted metrics such as the regulatory Tier I capital ratio.
- Ratio of risk-weighted assets to total assets is among the lowest in Europe, driven by:
  - use of internal rating-based (IRB) models applied to 96 percent of bank assets;
  - low default rates in recent years.
- Staff estimates of Swedish banks’ ‘leverage ratios’ are below the average of European peers.

### Regulatory and supervisory actions taken by FI
- May 2013: FI introduced a 15 percent floor for risk weights on Swedish residential mortgages to address IRB model risks.
- 2014: Floor raised to 25 percent as a macroprudential measure to target risks from high residential mortgage lending growth.
- May 2016: FI adopted a supervisory approach to internal models for corporate exposures requiring banks to assume that at least every fifth year is a downturn year when estimating default probabilities; following this approach, risk weights for corporate exposures are expected to be at least around 30 percent for all banks.

### Stress testing framework and scenarios
- The FSAP team and authorities implemented top-down (TD) solvency stress tests; results were compared with bottom-up (BU) EBA exercises.
- TD stress tests covered the largest four banks using a balance sheet approach; authorities ran a simpler framework projecting credit losses.
- Two five-year scenarios were considered:
  - Baseline: follows the IMF’s April 2016 World Economic Outlook.
  - Stress: reflects Sweden-specific shocks and spillovers from a global recession; entails an ‘L-shaped path’ for economic growth (deep recession followed by slow recovery due to domestic balance sheet adjustment).
- The first three years of IMF’s stress scenario dynamics are identical to the EBA 2016 adverse scenario for Sweden, but interest rate and exchange rate shocks are more severe.

### Key numeric elements of the IMF stress scenario (2015–2020)
- Real GDP: 4078.6; 4050.0; 3912.2; 3798.9; 3874.3; 3943.7
- Investment: 988.9; 984.8; 879.1; 819.9; 818.1; 827.9
- Unemployment rate: 7.4; 8.2; 10.1; 12.6; 13.5; 13.5
- HICP index: 100.7; 96.8; 96.5; 97.1; 97.7; 98.5
- Real house prices (1981=100): 129.2; 109.0; 95.9; 92.0; 90.8; 94.6
- Nominal house prices: 135.4; 109.4; 95.5; 92.1; 91.5; 96.1
- Short term interest rate (percent): -0.2; -0.5; -0.5; -0.5; -0.4; 0.1
- Long term interest rate (percent): 0.7; 2.4; 2.0; 1.9; 2.0; 2.5
- 2-year covered bond yield (percent): 0.2; 1.5; 2.5; 3.0; 3.5; 3.9
- 5-year covered bond yield (percent): 0.9; 2.3; 3.4; 4.0; 4.6; 4.9
- Equity prices: 1562.5; 1165.1; 1210.3; 1415.8; 1550.8; 1682.4
- KIX: 112.6; 115.6; 126.1; 124.0; 120.3; 113.8
- Real GDP growth (percent changes): -0.7; -3.4; -2.9; 2.0; 1.8
- Investment growth (percent changes): -0.4; -10.7; -6.7; -0.2; 1.2
- Inflation (HICP) (percent changes): -3.9; -0.3; 0.6; 0.7; 0.8
- Real house prices (yoy change) (percent): -15.6; -12.0; -4.1; -1.3; 4.2
- Nominal house prices (yoy change) (percent): -19.2; -12.7; -3.5; -0.7; 5.0
- Equity prices (yoy change) (percent): -25.4; 3.9; 17.0; 9.5; 8.5
- KIX (yoy change) (percent): 2.7; 9.1; -1.6; -3.0; -5.4

### Stress test results and implications
- In the stress scenario:
  - One bank would fall below the supervisory hurdle rate; no bank would breach the regulatory threshold.
  - Capital ratios were driven down by lower net interest income, higher credit losses, and increases in RWAs.
  - Credit losses driven mainly by losses on corporate exposures, with about two-thirds coming from non-Sweden exposures.
- TD tests produced lower capital ratios than BU tests due to more severe interest rate and exchange rate shocks and larger projected credit losses from authorities’ models.
- Recapitalization needed to bring all banks to the supervisory hurdle rate would peak in 2018 at 2 percent of nominal GDP.
- Single factor shock analysis indicated that shutdown of foreign exchange swap markets (increasing RWAs) would entail higher capital needs.

### Uncertainty, data gaps, and modeling issues
- Considerable uncertainty exists around capital ratios under stress; FSAP and authorities’ models produced larger losses than banks’ EBA estimates.
- Modeling tail risks in Sweden is challenging; available models may rely excessively on recent historical experience and fail to capture extreme but plausible non-linear scenarios (e.g., domestic housing distress combined with global turmoil).
- The solvency exercise identified data gaps and shortcomings:
  - Authorities’ solvency stress tests depend on many assumptions, particularly on pre-provision income and risk-weighted assets.
  - Recommendation to adopt modeling approaches that replace assumptions and allow projections of main balance sheet and income statement elements consistent with scenarios.
  - Authorities need longer time series of detailed balance sheet and income statements, and more granular data on trading and net interest as prerequisites for scenario-based stress testing.

### Policy recommendations for banks and supervisors
- Adopt a leverage ratio as a backstop in a timely manner to safeguard against model and measurement errors and to add resilience given Swedish banks’ systemic role in the region.
  - The leverage ratio is complementary to risk-based capital ratios and mitigates incentives to lower estimated risk weights instead of raising capital.
- FI should promote sensitivity of bank models to tail risks and investigate drivers of risk-weight variability.
- Strengthen liquidity monitoring and supervisory framework:
  - Consider an extended LCR for the three-month horizon in U.S. dollar and euro.
  - Investigate inconsistent results between compliance with the NSFR in foreign currencies and maturity ladder exercise outcomes.

### Funding, liquidity, and maturity transformation vulnerabilities
- Sweden has one of the highest loan-to-deposit ratios in Europe: about 200 percent.
- Customer deposits represent only about 40 percent of bank funding.
- Long-maturity residential mortgages rely on wholesale funding such as covered bonds with three-year average maturity.
- TD liquidity tests (short up to 30 days and medium up to one year) using Swedish LCR and Basel III NSFR indicate resilience within those parameters, but maturity ladder exercises beyond one month reveal large maturity mismatches for some banks due to reliance on foreign exchange wholesale funding.
- Parameters consistent with a Lehman-type scenario would lead to great short- and medium-term liquidity pressures.

### Contagion analysis
- Contagion analysis suggests limited risk of insolvency spillovers among the four largest banks, but with caveats:
  - Analysis likely underestimated spillovers because it did not capture all domestic interbank exposures and did not account for default risk outside the banking sector, including abroad.

---

### Insurance sector findings and recommendations
- Low interest rates are challenging for the life insurance sector:
  - The duration gap between assets and liabilities is among the highest in the EU.
  - Companies have reduced guarantees for new business and increased equity allocations.
  - Compared with European peers, Swedish insurers hold high equity exposures, making them vulnerable to a ‘double hit’ of prolonged low interest rates and an asset price fall.
- Insurance stress tests:
  - Covered four life and three non-life companies accounting for 78 and 53 percent, respectively, of gross written premiums in each sector.
  - An increase in the credit spread of Swedish covered bonds of 500 basis points could lead to a 7 percent reduction in the own funds of the median company.
  - The sector appears well capitalized on aggregate and able to withstand severe price shocks, though pockets of vulnerability exist mainly on the asset side.
- Recommendations:
  - FI should perform regular macroprudential stress tests that complement the Solvency II Standard Formula and companies’ Own Risk and Solvency Assessment, and incorporate a multi-period perspective.
  - If the Standard Formula does not adequately capture a company’s risk profile, assess the need for a Pillar 2 capital add-on.
- Additional insurance observations:
  - Bond investments with high coupon rates are going to expire soon, leaving insurers with significant reinvestment risks.
  - Large effects in stress tests stem from equity market shocks and default of largest banking counterparty.

*Source: IMF staff assessment as presented in the content unit.*

### 31.     The size of investment funds exacerbates the risks of transmission of redemption

### 31.     The size of investment funds exacerbates the risks of transmission of redemption shocks in the fund industry to the rest of the economy

### Investment funds — size, exposures, and redemption risk
- Total net assets of investment funds have increased by 70 percent since end-2011, driven mostly by equity and balanced funds.
- Open-ended investment funds are exposed to redemption risk: asset liquidation could represent a sizable shock for other institutions.
- The Premium Pension Authority represents 25 percent of total assets and alleviates some liquidity risks, but redeemed units reinvested in other investment funds would probably not be invested in the same assets sold by funds facing outflows, so redemption risk remains relevant.

### Stress-test findings
- Stress tests suggest that corporate bonds markets are the most exposed to redemption shocks (Figure 9).
- Methodology notes:
  - The test measured whether markets would be able to absorb severe redemption pressures by comparing assets sold by investment funds to turnover data.
  - Parameters were calibrated based on historical distribution of redemptions.
  - Results do not take into account that materialization of liquidity risks in other sectors would put additional pressures, and therefore may overestimate the markets’ absorption capacity.
- Figure 9 labels (approaches):
  - ‘Sold assets- pro-rata’ — assets sold by investment funds hit by a tail event redemption shock that have to sell their assets pro-rata (approach 1).
  - ‘Sold assets- assumed ordering’ — assets sold by investment funds hit by a tail event redemption shock that have to sell their assets in descending order of liquidity (approach 2).

### Policy recommendations on fund liquidity and monitoring
- The authorities should develop monitoring tools to continuously assess market sensitivity to extreme mutual fund redemptions.
- As funds continue to grow and possibly change their structure of investments, authorities should have liquidity risk analyses in place to examine effects of liquidity shocks to investment funds.

---

### D. Interconnectedness Across Institutions and Borders

### Cross-border and regional exposures
- Nordic-Baltic financial systems are highly interconnected through banks’ group structures.
- Swedish banks in Finland account for 70 percent of assets.
- Swedish banks account for the majority of financial intermediation in the Baltics: 80, 70, and 55 percent of total assets in Estonia, Lithuania, and Latvia, respectively.
- Nordea’s planned conversion of Nordic banking subsidiaries into branches (‘branchification’) would increase pressures on supervisory resources, potential systemic liquidity needs, and the contingent liability of the Swedish deposit insurance scheme.

### Covered bonds and interconnectedness
- Covered bond holdings among Swedish investors are driven mainly by insurance companies, other banks, and funds; major Swedish banking groups invest in covered bonds as liquid buffers and to act as market makers.
- As of end-2015:
  - Covered bond holdings were equivalent to about 85 percent of banks’ equity.
  - Swedish banks held 28 percent of the covered bonds outstanding in 2015 (Figure 10).
- Policy recommendation: Authorities should closely monitor banks’ cross-holdings of covered bonds and consider measures to contain potential contagion from correlated risks.

### Regional supervisory collaboration
- The Nordic-Baltic Macroprudential Forum (established in 2011) is an informal body for sharing financial stability concerns; it should continue with enhancements:
  - (i) publishing its risk assessments and updates on macroprudential developments in the region;
  - (ii) collecting exposure data for network stress tests among intermediaries in the region.

---

### Oversight framework — macroprudential, liquidity, and supervisory issues

### Macroprudential framework
- The macroprudential framework needs an upgrade: effective policy requires a clear mandate, well-defined objectives, adequate powers, and strong accountability.
- Current weaknesses:
  - FI’s macroprudential mandate rests on thin legal foundations; toolkit not fully developed.
  - Lack of separation of responsibilities between FI and government has slowed responses to emerging risks.
  - Riksbank (RB) has interpreted broadly its mandate to promote safe and efficient payments, but has no statutory role in macroprudential policy.
- Recommendations:
  - Law should clearly allocate financial stability powers between the government and FI; government should provide FI with a broad mandate and set of instruments, including the ability to adopt and change instruments and their calibration.
  - Strengthen the FSC’s financial stability responsibilities via a statutory mandate and recommendation power; give RB an important role in systemic risk analysis.
  - Upgrade FSC preparatory group to a Systemic Risk Committee, meeting more frequently and supported by RB and FI staff; recommendations should preferably have a ‘comply or explain’ attribute.
  - FSC should issue an annual financial stability assessment drawing on members’ stability reports.
  - Enhance financial stability analysis toolkit: conduct regular surveys on distribution of households’ financial assets; improve stress testing framework; allow FI to increase resources for systemic risk oversight and cross-institution supervisory issues.

### Systemic liquidity management and market liquidity
- Post-Lehman, banks built up short-term liquid buffers; LCR requirement of 100 percent was rolled out ahead of the Basel timetable; Swedish banks are required to meet LCR in euro and U.S. dollar.
- To date, all major Swedish banks have met the LCR requirements, with higher LCR ratios in major foreign currencies (Figure 11).
- Concerns and indicators:
  - Up to 33 percent of banks’ ‘high-quality liquid assets’ consists of covered bonds, equivalent to about 28 percent of total outstanding covered bonds in 2015 (including subsidiaries outside Sweden).
  - The Riksbank amended collateral terms and conditions in December 2015 recognizing concentration risks.
  - Turnover ratio for government bonds fell sharply at the onset of the global financial crisis, stabilized, then began declining from 2013 (Figure 12).
  - Bond price sensitivity to turnover in ten-year government bonds points to a smaller deterioration in market liquidity.
- Recommendations:
  - Closely monitor emerging deterioration in bond market liquidity.

### Foreign exchange liquidity and ELA
- The Riksbank can provide unlimited Swedish krona, but foreign currency injections require a foreign exchange buffer.
- Swedish banks had short-term external debt equivalent to about 50 percent of GDP at end-2015.
- Conversion of Nordea’s subsidiary banks in the region into branches would add an amount equal to a further 25 percent of GDP.
- The Riksbank will have responsibility to provide ELA to all Swedish banks, including their branches outside Sweden.
- Recommendations:
  - Ensure appropriate foreign exchange buffers; seek swap agreements with central banks in the Nordic countries, the Fed and the ECB.
  - Strengthen banks’ foreign exchange liquidity; monitoring an extended LCR beyond the one-month ELA horizon could reduce potential ELA needs.
  - Ongoing MoU work among Nordic central banks may help Riksbank access Norwegian and Danish kronor liquidity; the extended LCR should focus on euro and U.S. dollar.

---

### C. Banking — supervision resourcing and powers

### Progress and remaining gaps
- FI has progressed with supervisory approaches and techniques since 2011 (roll-out of Supervision Strategy, improved reporting).
- Remaining issues:
  - FI continues to be under-resourced relative to the size and complexity of the supervised system.
  - Bank supervision has less than 100 staff to supervise 124 institutions, including one G-SIB.
  - Consequences: limited analytical capability, too few examinations, over-reliance on a small number of key people; lack of experienced supervisors weakens capacity.
- Legal/regulatory constraint:
  - FI may issue regulations only in areas specifically vested by law or ordinance, causing long delays (e.g., credit risk standards).
- Recommendation:
  - Give FI a general power to issue binding regulations on safety and soundness issues.

---

### D. Insurance

- Solvency II has brought higher standards but is not applied in full, on a mandatory basis, to occupational pensions insurance.
- The requirements apply in full across only some 40 percent of the life insurance market.
- Sweden has allowed firms to exclude occupational pensions insurance from main solvency provisions.
- Recommendations:
  - Resolve uncertainties over regulatory approach after the end of the transitional period in 2019.
  - Ensure occupational pensions receive the same level of protection as life insurance under the post-2019 regime.
  - Strengthen supervisory framework: overlay risk-based allocation with minimum staffing levels, an extended range of minimum supervisory activities for highest impact entities, and increased resourcing for teams addressing highest risk companies.
  - Increase resources and broaden the mandate for FI’s consumer protection function to address major issues (e.g., future of commissions-based remuneration).

---

### E. Securities markets and FI’s supervisory capacity

- FI’s Consumer Protection and Markets Areas have primary responsibility for securities markets supervision; combined staff approximately 140, with high turnover in Markets Area of 28 percent between January 1 and November 30, 2015.
- Recommendations:
  - Review Consumer Protection Area activities to incorporate explicit consideration of financial stability risks where necessary (noting increased risks from fund management).
  - Improve data availability and quality and develop better analytical tools; solving reporting challenges is a precondition.
  - Authorities encouraged to cooperate in data collection and analysis; FI should acquire an automated market surveillance system to supervise cross-market and cross-border trading.
  - Wider communication of inspection findings and recommendations: FI should develop tools to communicate thematic inspection findings and recommendations to all supervised entities and, where relevant, to the public.

*Source: IMF staff report excerpt (pages provided).*

### 57.     Enhancements to cross-border supervisory cooperation and active participation in

### 57.     Enhancements to cross-border supervisory cooperation and active participation in

### Cross-border supervisory cooperation and EU engagement
- Enhancements to cross-border supervisory cooperation and active participation in the work of the European Securities and Markets Authority are necessary complements to FI’s current active domestic supervisory program.
- It is important to continue to build closer cooperation with FI’s key foreign counterparts, in particular in the Nordic region and Luxembourg.
- FI should actively raise issues for discussion at European Securities and Markets Authority to enhance EU level convergence to avoid regulatory arbitrage.
- Rationale: increased ability of fund managers, funds and investment service providers to choose their domicile within the EU.

### Financial Market Infrastructures (FMIs)
- FMIs are well developed and subject to minimum regulatory requirements established in relevant international standards.
- There is overlap in the supervision and oversight by FI and the Riksbank; arrangements have been established to facilitate cooperation.
- Evidence indicates the authorities speak with one voice where relevant, but FI and the Riksbank should clarify how they would coordinate during a (non-resolution) crisis, possibly by establishing a joint crisis management plan.
- Risk management at Nasdaq Clearing:
  - Appears sound.
  - Lacks a comprehensive and well-developed recovery plan to ensure critical services in times of crisis.
  - Should have the ability to comprehensively address credit losses and liquidity shortfalls.
  - All recovery tools must be backed by formal agreements or be in the rulebook, as appropriate.
  - FI and the Riksbank have recognized the need for further development, and Nasdaq Clearing has begun work in this area.
  - EU legislation, expected to be introduced in late 2016, should provide additional certainty and ensure that authorities have enforcement powers.13
- Resource adequacy:
  - The mission encourages FI and the Riksbank to continue reviewing the adequacy of resources for FMI oversight and supervision.
  - Effective cooperation helps alleviate pressures but international policy work and increasing demands in other areas can increase pressures.
  - Additional resources will also need to be devoted to work on FMI crisis management when EU legislation on central counterparty resolution is introduced.
- Recommendation:
  - FI and the Riksbank should clarify how the two authorities would coordinate in a crisis, involving establishing a joint crisis management plan.
  - Further work will be required when the EU legislation regarding central counterparty resolution is implemented, possibly with a wider range of authorities.

*13 See also the “Supervision and Oversight of Financial Market Infrastructures” Technical Note.*

### Financial integrity (AML/CFT)
- Sweden has made significant progress since the 2006 assessment:
  - Strengthened the legal framework.
  - Covered national and sectoral money laundering/terrorist financing risk assessments.
  - Developed a national AML/CFT strategy.
- Important shortcomings remain:
  - Low risk customers are completely exempt from customer due diligence requirements.
  - Identification and verification of beneficial owners could be improved.
  - Suspicious transaction reports from specific sectors are of low quantity and quality.
- Recommendations to enhance effectiveness:
  - Improve understanding of money laundering/terrorist financing risks.
  - Enhance cooperation on AML/CFT among stakeholders.
  - Address the customer due diligence exemption.
  - Establish a register of beneficial ownership through legislation.
  - Provide feedback to reporting entities on improving suspicious transaction reports.
- Note: The Financial Action Task Force is assessing the AML/CFT regime under the revised standard, and is expected to finalize its report in 2017.14

*14 The Financial Action Task Force is assessing the AML/CFT regime under the revised standard, and is expected to finalize its report in 2017.*

### Crisis readiness, management, and resolution
- Actions taken since the 2011 FSAP:
  - Held a crisis simulation exercise in late 2014; a new crisis simulation exercise is under preparation.
  - In mid-2011, revised the deposit insurance scheme through implementation of EU directives, including FSAP recommendations to shorten the payout period and to redefine the payout trigger.16
  - In early 2016, vested the National Debt Office (NDO) with resolution authority and established a bank resolution regime by implementing the EU’s Bank Recovery and Resolution Directive (BRRD).17
- Remaining needs and observations:
  - The overhauled framework is untested; further investments are needed to rapidly deploy recovery and resolution tools.
  - Additional resources required for:
    - A new resolution handbook to operationalize the resolution toolkit.
    - An updated early intervention manual to ensure consistency with the BRRD.
    - The first recovery and resolution plans for all 200 banks and investment companies.
  - FI and NDO appear understaffed when benchmarked against other EU countries’ agencies, particularly given Sweden’s home-country responsibilities (no official metrics exist to assess staffing needs).
- Transition and cooperation:
  - The introduction of the special bank resolution regime requires a smooth transition from early intervention by FI to resolution by the NDO.
  - Close cooperation between FI, NDO, and the Riksbank is important in assessing solvency and viability of institutions receiving ELA from the Riksbank, particularly during resolution.
  - Existing MoUs between the agencies should be updated.
  - As home country for one G-SIB and three other major cross-border banks, Sweden will need comprehensive bi- and multilateral cross-border arrangements to ensure effective recovery and resolution, including of systemic Swedish bank branches.
  - Recommendation: a revamped Nordic-Baltic Stability Group could oversee cross-border crisis preparedness and management.
- Riksbank mandate and ELA:
  - Recommendation to clarify the Riksbank’s financial stability mandate and related powers to provide liquidity assistance.
  - Riksbank’s financial stability mandate should:
    - Include a clear role in the oversight of systemic risk.
    - Contain explicit confirmation of statutory authority to extend ELA for financial stability purposes to individual institutions (‘idiosyncratic ELA’) and the system as a whole (‘systemic ELA’).
  - Recommend introducing a special clause in the Riksbank Act and defining strategies to provide liquidity to banks in resolution.
  - To strengthen ELA in foreign currencies if Riksbank FX reserves are insufficient, recommend the Riksbank seek swap agreements with central banks of jurisdictions where Swedish banks operate through branches.
  - To protect the Riksbank’s balance sheet against potential exposures due to ELA, recommend considering complementary ex ante, standing indemnification and guarantee arrangements for any ELA losses if incurred by the Riksbank without subjecting each ELA operation to ad hoc approval from third parties.
  - Purpose: promote the Riksbank’s financial and operational autonomy.
- National contingency planning:
  - Responsibility to actively oversee national contingency planning, including national and cross-border financial crisis simulation exercises, has not been assigned; nor is there a national contingency plan.
  - Recommendation: expand the FSC’s mandate to include oversight of contingency planning, requiring the supporting preparatory group and FSC secretariat to include contingency planning expertise.
  - The FSC would remain a platform for inter-agency coordination while agencies continue to use their powers within their mandate.

*15 See also the “Financial Safety Net and Crisis Management” Technical Note.*  
*16 The deposit insurance scheme appears well-funded, at more than twice the EU target level, although the contingent liability may increase with Nordea’s ‘branchification’ (Box 1).*  
*17 After concluding the public consultation, the NDO aims to adopt its policy on minimum requirements for own funds and eligible liabilities (MREL) in Q4 2016 when it also expects to take the first MREL decisions when adopting resolution plans for the four cross-border banks. Meanwhile, it has set MREL equal to required capital.*

### Box 1 — Proposed Conversion of Nordea’s Nordic Banking Subsidiaries to Branches
- Context and scale:
  - In May 2016, Nordea, the largest financial services group in Northern Europe, with assets of about EUR 650 billion, received approval from Sweden’s FI to convert its Danish, Finnish, and Norwegian subsidiary banks to branches of its Swedish bank.
  - These subsidiary banks are currently supervised by national authorities in Denmark, Finland, Norway, and the ECB.
  - Nordea’s assets are equivalent to 140 percent of Sweden’s GDP.
  - The Financial Stability Board has designated Nordea as one of 30 G-SIBs.
- Implications:
  - The majority of Nordea’s funding is wholesale, and most of its balance sheet is in currencies other than SEK.
  - As a G-SIB, Nordea should be subject to more intensive and effective supervision, commensurate with potential destabilization risks.
  - Under CRD-IV, virtually all authority for supervision and resolution of international branches is assigned to the home competent authority.
  - Absent agreements with other Nordic countries and the ECB to share resources, Sweden’s FI will need to assign its supervisors to replace Danish, Finnish, Norwegian, and ECB supervisors.
  - The Riksbank will become Nordea’s primary central bank, and the Swedish government will become the primary deposit insurer and be responsible for any potential resolution.
  - Supervisors in Denmark, Finland, Norway and at the ECB expressed concerns that CRD-IV had not anticipated branches that are among the top three or four banks and impose systemic risks on host countries.
- Views of Swedish authorities:
  - The Riksbank recommended that Swedish FI impose liquidity coverage ratios on Nordea in Danish and Norwegian kronor, be given additional resources, and be given clear authority to implement macroprudential measures consistent with those in the other countries; it also suggested tightening capital requirements of the four major Swedish banks.
  - The NDO’s view: risk to the state is not greatly affected by Nordea’s plans; the reorganization would extend Sweden’s formal liability for deposit guarantees and resolution but the increase in the sovereign’s financial commitments would be limited. NDO noted that the new arrangements for handling a banking crisis applied since February 2016 mean that costs of resolution are mainly borne by the bank’s owners and lenders, and in NDO’s assessment the ‘branchification’ could mean an improvement in conditions for effective and orderly handling of a crisis.
  - The Swedish FI, in its decision granting Nordea Bank AB the authorization to execute the merger plans, concluded that Nordea’s transformation would not significantly increase risks to public interests, nor would it impair the conditions for handling a crisis, or that the Swedish State’s potential commitments would be significantly increased.
  - FI considered applying a temporary own funds requirement during the transition period, committed to carefully monitoring Nordea Bank AB’s contingency plans for liquidity and funding, conduct more frequent and comprehensive supervision, and, if necessary, widen the scope of the bank’s reporting.
- Recommendation:
  - Relevant supervisors, central banks, and ministries of finance should work on agreements to ease concerns of host countries and the ECB while providing support to Sweden if it is to take on these additional responsibilities.

1 http://www.fi.se/upload/90_English/20_Publications/20_Miscellanous/2016/beslut-bilaga-nordea-16-maj-2016-eng2.pdf

*Italic: IMF staff report content as provided in the source.*

### Appendix I. Follow-up on the 2011 FSAP’s Key Recommendations

### Appendix I. Follow-up on the 2011 FSAP’s Key Recommendations

### Institutional framework and crisis management
- Establish a high-level FSC — Implemented, but further steps needed
  - Agreement between seven parties in the Swedish Parliament on principles of the macroprudential framework reached in 2013.
  - Government appointed FI as the Swedish macroprudential authority and established the FSC; the FSC became operational in the beginning of 2014.
  - The FSC is a forum for government, FI, the NDO, and the Riksbank to discuss financial stability and counteracting financial imbalances; agencies decide independently within their mandates.
- Reconstitute the mandate of the Domestic Standing Group to focus on contingency planning and crisis management — Implemented, but further steps needed
  - Contingency planning and crisis management strengthened by FSC establishment and the BRRD (Bank Recovery and Resolution Directive).
- Hold crisis simulation exercise with all four parties to the domestic MoU — In progress
  - Fall 2014: Ministry of Finance with FI, NDO, and Riksbank ran seminars/workshops (more than 30 participants) simulating BRRD resolution scenarios.
  - Legislation implementing the BRRD entered into force in Sweden in February 2016.
  - Ongoing preparatory work within the FSC for an upcoming crisis simulation exercise.
- Formalize communication between RB and FI in assessing institutions’ solvency and viability in the context of emergency liquidity assistance — Implemented
  - MoU between FI and Riksbank (2009) establishes routines, an advisory group meeting every three months, and strategic consultation responsibilities.
  - The new Resolution Act introduces obligations for consultation between authorities prior to considering resolution.

### Prudential supervision, legal powers, and resources
- Increase FI’s resources to ensure effective supervision — Implemented, but further steps needed
  - Appropriations assigned: SEK 103 million (for 2012–2014) and an additional SEK 100 million (for 2014–2016).
  - Appropriations rose from SEK 284 million in 2010 to SEK 491 million in 2016.
  - Additional funds used for banking, consumer protection and macro analysis; systems development for new legislation and reporting (e.g., EU Capital Requirements Regulation).
  - New tasks for FI include macroprudential supervision and supervision of new company categories.
- Enhance the operational independence of FI in discharging its supervisory responsibility — Implemented, but further steps needed
  - 2013 ordinance changes strengthened FI independence in setting priorities within its legal mandate.
  - Government Bill 2012/13:95 removed government ability to assess/authorize bank and insurance activities; authorization is now solely FI’s competence.
  - The appropriations letter for FI has become substantially shorter compared to 2010; reissuance has only concerned marginal issues and specific assignments.
  - Budget Act principle: fees collected by a government agency are not to be used directly by that agency; FI disposes of certain fees under an exception for cost-covering applications.
- Broaden scope of FI’s discretion in issuing binding secondary regulations in the insurance sector — Implemented
  - Insurance Business Act (SFS 2010:2043) (April 2011) provided FI a wider mandate to issue principle-based regulations (Chapter 4, section 18).
  - Changes to Chapter 1, section 23 (effective January 2016) grant FI a wide mandate concerning minor insurance companies.

### Market integrity, infrastructure, and resolution
- Enhance crime prosecution in the securities market sector including for insider dealing and market manipulation — Implemented
  - January 2012: Swedish Economic Crime Authority established Financial Markets Chamber (FMK) to specialize in financial market offences (insider dealing, market manipulation, swindling in listed companies).
  - Since FMK establishment: improved investigation methods, increased use of coercive measures, better cooperation with market places and FI, shortened processing times.
  - July 2011: Preparation of aggravated insider offences criminalized; penalty up to two years imprisonment.
  - January 2015: MoU formalized cooperation between FMK and FI — strategic meetings twice yearly and specific-case dialogue; collaboration meetings every two months.
- Enhance NOMX DM’s risk management and separate financial resources between NOMX DM and NOMX COM — Implemented
  - Nasdaq Clearing authorized under EMIR since March 2014; clearing business separated into a distinct legal entity.
  - Member-contributed default funds introduced: three different default funds (one per clearing line).
  - Governance enhanced via member representation and advisory/ risk committees.
  - Collateral management system upgraded; bank guarantees not fully backed by collateral phased out for commodity business lines; exemption lasted until mid-March 2016.
  - Liquidity sources diversified: multicurrency credit lines with four liquidity providers (three major Scandinavian banks and one non-Scandinavian bank), and intraday credit access with the Riksbank.
  - Investment policy allows investments below AAA but with limits.
- Review laws to address legal uncertainty related to settlement finality and collateralization procedures — Implemented
  - Amendment to Chapter 3, section 2 of the Bankruptcy Act (SFS 1987:672) clarifies that a bankruptcy estate cannot request return of transfers of financial instruments, currencies, gold or certain credit claims; removes prior uncertainty about transfers entered into a designated settlement system after notice of bankruptcy.
  - Amendment entered into force on 1 March 2015 following a Government bill presented in June 2014.
  - No explicit provision for bankruptcy of non-Swedish participants; systems can manage this (e.g., legal opinion requirements).
- Review its act to allow RB to issue regulations and clarify division of responsibilities between RB and FI — Implemented
  - Ministry of Finance initiated a project to clarify Riksbank powers regarding actors within the central payments system.
  - Riksbank oversees financial infrastructure to safeguard system stability; FI supervises individual FMIs and grants licenses for clearing, settlement and central counterparty operations.
  - Formalized cooperation exists; authorities develop efficient contact/cooperation forms where responsibilities overlap.

### Deposit insurance, resolution regime, and public support
- Carry out a reform of deposit insurance including shortening the payout period and redefining the payout trigger — Implemented
  - 2011 government bill implemented Directive 2009/14/EC amendments to Directive 94/19/EC.
  - Payment period for compensation shortened to 20 days.
  - Introduced stricter disclosure obligations for institutions and authorities and a new alternative process for initiating compensations.
- Introduce a special bank insolvency regime with possibility of deposit insurance fund support for bank restructuring — Implemented
  - BRRD entered into force in Sweden in February 2016 via two new laws and changes to national laws.
  - NDO designated as resolution authority for individual institutions; FI given enhanced supervisory tasks to prevent resolution situations.
  - New resolution reserve created and financed by sector contributions to cover costs of reconstruction and resolution measures.
  - Two new laws: the Resolution Act and the Act on Preventive Public Support to Credit Institutions; changes also imposed on the Banking and Financing Business Act and the Securities Market Act.
  - With BRRD implemented, owners and lenders primarily bear losses; state steps in as last resort.

### Data, monitoring, and household indebtedness
- Monitor closely the performance of mortgage loans — Ongoing
  - FI required to present a biannual stability report (per government’s appropriations letter).
  - FI produces an annual mortgage survey including micro data on household level and collects aggregate data to follow indebtedness for new borrowers over time.
  - FI assesses amortization behavior changes and performs household resilience stress tests.
  - Household indebtedness regarded as a systemic issue by Riksbank and FI; thoroughly monitored with various publications since 2011.
- Collect and monitor regularly loan default rates and NPLs by sector and geographical allocation — Implemented
  - FI to assess in its biannual stability report credit lending/conditions to households and businesses, including SMEs.
  - FI collects and monitors loan default rates and NPLs each quarter through European reporting frameworks (Corep and Finrep).
  - Risk Assessments under the Supervisory Review and Evaluation Process analyze and compare NPL and past due loan development across banks, geographies and portfolios.

### Anti-money laundering, sanctions, and beneficial ownership
- Establish measures to enable freezing of all funds related to terrorism financing (EU internal terrorists implementation gap) — In progress
  - 2006 inquiry (Sanktionslagsutredningen, SOU 2006:41) proposed national legislation to supplement EU system where needed; reform put on hold in 2009 pending Article 75 of EU Lisbon Treaty developments.
  - Committee of Inquiry (2015:91) tasked to propose an effective system for Sweden to implement targeted economic sanctions concerning terrorism and financing of terrorism and to submit necessary legislative proposals; report due by November 3, 2016.
- Amend the legal framework to require current beneficial ownership information — In progress
  - Implementation of the fourth anti-money laundering directive will introduce a central register for beneficial ownership information in Sweden.
  - An official inquiry presented a proposal in February 2016; the Ministry of Finance is working on a legislative proposal.
  - New legislation expected to be in force by June 2017.

### Stress test appendix (summary of assumptions and scope)
- Banking sector: solvency risk — scope and data
  - Institutions included: Four largest bank holding companies.
  - Market share: 75 percent of total banking sector’s assets.
  - Baseline date: 2015 Q4 (for Bottom-Up by Financial Institutions, Top-Down by Authorities, and Top-down by FSAP Team).
  - Data sources: Banks’ own data (bottom-up); publicly available data (top-down by authorities); supervisory data (top-down by FSAP Team).
- Methodologies and channels of risk propagation (high-level)
  - Bottom-Up by Financial Institutions:
    - Banks’ internal models constrained by EBA guidelines.
    - Banks required to calculate, under EBA scenarios and methodology, potential losses, pre-provision net revenue, provisions for loan losses and capital levels as functions of scenario macro/financial variables.
    - Net interest income projected by banks’ own methodologies with caps (margins constrained); operational risk losses subject to a floor; administrative and operating expenses could not fall below 2015 values.
    - Stress test horizon: 2015Q4–2018Q4.
  - Top-Down by Authorities:
    - Simple top-down approach by Riksbank and FI focused on modeling loan losses.
    - Provisions for loan losses projected using a model fitting historical credit losses bank-by-bank to macro variables conditional on stress scenarios; distribution across asset classes via a second model.
    - Static balance sheet assumption; pre-provision net revenue projected with a 20 percent haircut.
    - Stress test horizon: 2015Q4–2020Q4.
  - Top-down by FSAP Team:
    - Balance-sheet based approach modeling income statement and balance sheet items (loans and funding) as functions of scenario macro variables; growth rate of balance sheets in stress scenario set to zero (adjusted for exchange rates and mark-to-market losses).
    - Net interest income via maturity gap analysis under a general increase in interest rates; margins calculated using the EBA methodology.
    - Non-interest income and expenses projected using panel regression models; trading income losses assessed via duration approach; AOCI unrealized losses on AFS securities via duration approach.

*Source: Appendix I. Follow-up on the 2011 FSAP’s Key Recommendations (IMF).*

### 3. Tail shocks Scenario

### 3. Tail shocks Scenario

### Analysis
- Baseline: EBA baseline scenario.
- Stress: EBA stress scenario reflecting Sweden-specific risks as well as spillovers from a recession in the Nordic and Baltic region. The Sweden-specific stress scenario was driven by a confluence of shocks to produce a deep recession. Recovery was slowed by domestic balance sheet adjustments, so the overall GDP profile is somewhat ‘L-shaped’.
- In the stress scenario:
  - unemployment rate rose by a 6 percentage point rise over a four period.
  - The cumulative growth rate of real GDP was equal to 7 percent over the first three years (GDP growth rates were negative for three years).
  - equity prices fell by 25 percent in the first year.
  - house prices declined by 35 percent over the first three years.
- The Sweden-specific macro scenarios were supplemented with a set of scenarios for the Nordic and Baltic region.
  - Baseline: IMF’s World Economic Outlook baseline scenario as of April 2016 and EBA baseline.
  - Stress: EBA stress scenario with more severe interest rate (100 bps in the first year) and exchange rate (10 percent depreciation) shocks.
- Interest rate risk in the banking book: steepening of the yield curve depending on currency (e.g., 100 bps widening in the short end of the curve; 350 bps widening in the long end of the curve for Sweden).
- Market risk shocks on Trading, AFS securities and CVA:
  - Equity index shocks: OMX by 40 percent, S&P 500 by 30 percent, Stoxx 50 by 50 percent, MSCI Asia (e.g., Japan) by 40 percent, Nikkei 225 by 30 percent.
  - Currency valuation shocks: 40 percent depreciation of the SEK against the U.S. dollar, 20 percent depreciation against the euro, 30 percent depreciation against GBP.
  - Commodity price decline: energy, base metals, precious metals and grains by 40, 40, 25, and 30 percent, respectively.
  - Interest rates (depending on the currency and maturity) and credit spreads (depending on exposure) increase.
- Counterparty default shock (top 10 exposures).
- Shutdown of foreign exchange swaps market: impact on net open position and capital, CCR risk-weighted assets and credit risk-weighted assets.
- Low interest rates for a long time.
- Constant loan supply versus dynamic forecast of credit (modeled using panel regression model and macro and financial variables as independent variables).
- Less severe interest rate shock in the baseline.
- Corporate sector stress test.

### Sensitivity analysis / one-time add-on shock
- N.A.

### Risks and Buffers (Credit, Market, Operational, Taxes)
- Credit risk (granular sectoral exposures) including securitizations:
  - Banks’ internal models based on stressed point‐in‐time PD and LGD parameters and grade migration; Prescribed loss parameters for sovereign exposures.
- Market risk, CCR and CVA:
  - Full revaluation of the trading and AfS/FVO portfolio; Default of the two most vulnerable of the 10 largest stressed CCR exposures.
- Operational risk, including conduct risk:
  - Banks’ own projections for the advanced measurement approach (AMA), basic approach and standard approach.
- Taxes:
  - a common simplified tax rate of 30 percent.
- Top-down / FSAP team assumptions:
  - Credit risk (granular sectoral and geographical exposures).
  - Tax rate: After-tax net income (or loss) was calculated by applying a consistent tax rate to pre-tax net income (or loss).
  - Credit risk (households, corporates, sovereign, financial institutions exposures): estimated according to Basel III framework, under IRB approach.
  - Market risk: mark-to-market valuation of securities in trading book and AFS/FVO using the duration approach.
  - Taxes: set at the pooled average tax rate over the last 20 years.
- Behavioral adjustments (BU / top-down differences):
  - Bottom-Up by financial institutions:
    - Dividend, fees and commission remained constant in the baseline; minimum of the ratio to total assets of 2015 and the average of the two years with the smallest value that occurred 2011–15 in the stress scenario.
    - For dividends paid: Pay‐out ratio was based on publicly declared dividend policies. If no policy was available, the pay‐out ratio in the baseline was the maximum of 30 percent and the median of the pay‐out ratios in profitable years 2011–15; in the stress scenario, the same amount of dividends was assumed (0 accept for loss‐making banks).
    - The static balance sheet assumption.
  - Top-Down by authorities:
    - The constant balance sheet assumption.
    - If after tax net profit was positive, a dividend ratio of 75 percent was assumed.
  - Top-down by FSAP Team:
    - Constant and dynamic balance sheet assumptions were analyzed; for the dynamic case the balance sheet growth and funding growth were modeled and forecasted using a panel regression with fixed effects and macro variables as exogenous variables.
    - Dividend payout schedule followed capital conservation rule; banks could distribute maximum dividend amount equal to dividend payout ratio (dividends over net income) in the base-year (2015) if they were not capital constrained; dividends were paid out only if bank records profits.
    - Asset disposals and acquisitions over time not considered; the portfolio composition remained unchanged over time, with maturing exposures replaced with similar ones.

### Regulatory and Market-Based Standards and Parameters
- Calibration of risk parameters:
  - Banks used their models rather than resort to benchmarks to determine stressed PD and LGD parameters.
  - Banks employed a rating transition matrix‐based approach, considering the effects of PD/LGD grade migration on the level of default and impairments.
  - For corporate exposures (and retail SME) PD was modelled using EDFs for all country exposures, except for the Baltic countries. PDs for household exposures were based on the level of indebtedness and the level of unemployment. The model estimates for PD were also subject to expert judgment. LGDs projected losses distributed across different asset classes and countries.
  - Projected point in time PDs for each asset class (and country) calculated as projected loan losses for each asset class/(LGD x projected exposures by asset class).
  - Downturn LGDs provided by banks—stayed constant at 2015Q4 level.
  - Point in time PDs and downturn LGDs used for both credit losses and stressed risk-weighted asset calculations.
- Regulatory / Accounting and Market-Based Standards:
  - Capital standards: Basel III capital.
  - Capital metrics: Tier 1 common capital ratio, common equity tier 1 ratio, Tier 1 capital ratio, total capital ratio and the leverage ratio; all ratios reported on a transitional and a fully loaded basis.
  - Hurdle rates: NA; hurdle rates used from the IMF top down approach.
  - Top-down FSAP team specifics:
    - Capital standards: Basel III CET1 capital, leverage ratio.
    - Capital metrics: Common equity tier 1 ratio, Basel III leverage ratio.
    - Hurdle rate: regulatory hurdle rate (Basel III regulatory minimum, other Pillar 2 own-fund requirements associated with pension risk, concentration risk and interest rate risk in the banking book, microprudential mortgage floors) and local supervisory requirements that took into account the buffers (systemic risk surcharge, the countercyclical capital buffer, and macroprudential mortgage floors).
    - 100 percent of AOCI phase out from CET1 capital from 2016 onwards.
    - 100 percent phase in factor on deductions from CET1.
  - Risk-weighted assets—credit risk:
    - CRR requirements based on stressed PD and LGD parameters; a prescribed increase in REA for securitization exposures, as well as prescribed shocks to credit risk losses for sovereign exposures; risk-weighted assets floored by 2015 value.
    - Using Basel II, IRB formula that translated downturn LGDs, changes in through the cycle PD (that are adjusted for projections of point-in-time PDs), changes in assets correlation, the maturity adjustment parameter and exposures (also into stressed risk-weighted assets).
  - Risk-weighted assets—market risk:
    - based on a common set of stressed market parameters, calibrated from the macroeconomic scenario, as well from historical experience, and on haircuts for sovereign exposures; constant for STA approaches; VaR constant in the baseline and replaced by SVaR in the stress scenario; Stressed IRC and CVA capital requirements; Prescribed haircuts for AFS/FVO sovereign positions; risk-weighted assets for IRC and CVA floored by the increase for IRB REA; Prescribed simplified approach based on historical NTI volatility for HFT (adjusted for depreciation of SEK) into stressed risk-weighted assets.
  - Risk-weighted assets for market and operational risk taken from the banks, reported for the BU test.
  - Risk-weighted assets: risk weights went up by 75 percent per year for the first three years and 0 afterwards (top-down authority approach).
  - Market risk-weighted assets and Operational risk-weighted assets were not considered (authority BU column).

### Reporting Format for Results (banking)
- Distribution of CET1 ratios by bank in the baseline and stress scenario.
- Contribution to the change in system wide CET1 ratio in the baseline and stress scenario.
- Contribution of each component of the income statement to change in profits in the baseline and stress scenario.
- Structure of losses (by sectors and countries).
- Evolution of PDs.
- Number of banks and share of total assets below hurdle rates.
- Capital shortfall under each scenario relative to GDP.
- Results of sensitivity analysis.

### Banking Sector: Liquidity Risk
- Institutional perimeter:
  - Four largest banks.
  - Market share: 75 percent.
  - Data and baseline date: Supervisory data (COREP, FINREP); Consolidated banking group as of 2015Q4.
- Methodology:
  - Swedish LCR (‘old’ Basel III version) by currency.
  - Proxy NSFR by currency.
  - Cash flow analysis using maturity ladder by currency.
- Tail shocks:
  - Shocks reflected in adjustment factors (haircuts and run-off rates) applied to high-quality liquid assets/counterbalancing capacity and outflows; Factors were informed by the Basel III liquidity metrics (baseline scenario) and more severe episodes of market and funding risks (stress scenario).
- Risks and buffers:
  - Risks: Funding liquidity risk, rollover risk; Market liquidity shock.
  - Buffers: Liquid assets/Counterbalancing capacity.
- Calibration of risk parameters:
  - Baseline scenario: haircuts and run-off rates calibrated based on the LCR/NSFR.
  - Stress scenario: stressed LCR (parameters were broadly consistent with the Lehman type liquidity squeeze, as documented by Schmieder and others (2011)) and NSFR (The parameters of the stress scenario were adjusted by 10 percentage points comparing to the baseline).
  - For LCR and NSFR threshold set to 100.
  - For maturity ladder based on survival horizon.
- Reporting:
  - Distribution of LCRs and NSFRs by currency, by bank.
  - Survival period of each bank in the baseline and stress scenario.
  - Drivers of banks’ liquidity position and high quality liquid assets/counterbalancing capacity, for each scenario.

### Banking Sector: Spillover Risks
- Institutional perimeter:
  - 4 largest banks; 75 percent of banks’ assets; data baseline 2015Q4.
- Methodology:
  - Espinosa and Sole (2013) network analysis based on a matrix of bilateral exposures.
- Tail shocks:
  - Credit (default of each bank) and funding shocks.
  - Parameters for LGD, and the share of funding previously granted by the defaulted banks that non-defaulted banks are unable to replace and the fire-sale discount were set to 25 percent. In the sensitivity analysis, the parameters were doubled.
- Risk:
  - Contagion risk.

### Insurance Sector: Solvency Risks
- Institutional perimeter:
  - 4 life insurers; 3 non-life insurers.
  - Market share: Life: 78 percent (gross written premiums); Non-life: 53 percent (gross written premiums).
  - Consolidation level: Groups’ worldwide consolidated business (if applicable).
  - Data: Companies’ own data; Top-down: Companies’ own data, mainly based on regular supervisory reporting.
  - Baseline date: 01/01/2016.
- Methodology and horizon:
  - Companies’ internal calculations / Balance sheet-based approach.
  - Companies’ asset and liability cash flow projections (60 years).
  - Companies’ data on fixed-income portfolio and guaranteed interest rates.
  - Asset shocks assumed to occur instantaneously.
  - Participants provided projections for a three-year horizon (2016-2018) assuming unchanged interest rates, risk premia and asset prices after the shock has occurred.
  - Top-down: Long-term projection for asset-liability mismatches.
- Tail shocks / Scenarios:
  - European Insurance and Occupational Pensions Authority ‘double-hit’ scenario: low risk-free interest rates and increase in risk premia.
  - IMF stress scenario: broadly in line with macrofinancial scenario used in the banking ST.
  - Low-for-long interest rate scenario.
- Sensitivity analysis (bottom-up list):
  - 500 bps increase in Swedish covered bond spreads.
  - Longevity shock: Permanent 20 percent decrease in mortality rates (life insurers only).
  - Mortality shock: Permanent 15 percent increase in mortality rates (life insurers only).
  - Pandemic event: Temporary 35 percent increase in disability/morbidity rates for the next 12 months.
  - Catastrophic event (non-life insurers only): Windstorm: Repetition of windstorm Gudrun, hitting the Nordic countries in 2005.
  - U.S. hurricane: Repetition of hurricane Andrew in 1992.
- Risks and buffers:
  - EIOPA ‘double-hit’ scenario components (bottom-up):
    - Interest rate shock: one-year SEK risk-free rate: -60 bps; 10-year: -63 bps.
    - Equity shock: -28.4 percent for Swedish stocks.
    - Property shock: -4.6 percent for Swedish residential real estate; -4.2 percent for Swedish commercial property.
    - Sovereign credit spread: +141 bps for 10-year Swedish government bonds.
    - Corporate credit spread: Increase between 16 bps (for AAA financials) and 516 bps (for unrated financials).
  - IMF stress scenario (bottom-up):
    - Interest rate shock: one-year SEK risk-free rate: -33 bps; 10-year: +32 bps.
    - Equity shock: -25.4 percent (domestic and global).
  - Top-down / FSAP team scenario components:
    - Property shock: -32.5 percent (domestic), -20 percent (global).
    - Sovereign credit spread: Increase in credit spreads of Swedish government bonds by 136 bps.
    - Corporate credit spread: Increase in credit spreads between 50 bps (for AAA) and 300 bps (for BB and lower).
    - Default of largest banking counterparty (100 percent write-off for equity and subordinated bonds, 50 percent write-off for unsecured bonds, 15 percent write-off for secured bonds).
    - Currency shock: 13.9 percent depreciation of SEK.
    - Mass lapse event: Discontinuance of 20 percent of insurance policies for which discontinuance would result in an increase of technical provisions without the risk margin are discontinued.
  - Risk aggregation: All shocks of the scenarios were assumed to occur together and simultaneously, therefore summation of shock effects within each scenario, no diversification effect.
  - Buffers (bottom-up): Absorption effect of technical provisions (profit sharing); Absorption effect of deferred taxes; Absorption effect of ‘long-term guarantee measures’ as part of the Solvency II framework.
  - Top-down / FSAP team: None.
  - Behavioral adjustments: Management actions limited to non-discretionary rules in place at the reference date (bottom-up); Top-down: None.
- Regulatory and valuation parameters:
  - Regulatory regime: Solvency II. Solvency I for occupational pension business pursued under Art. 308 of the Solvency II Directive.
  - Valuation: National GAAP (market-consistent).
- Reporting format:
  - Impact on solvency ratios.
  - Impact on net income.
  - Dispersion measures of solvency ratios and net income.
  - Top-down: Impact on valuation of assets and liabilities; Impact on available own funds and solvency ratios; Capital shortfall under each scenario in nominal terms and relative to GDP.

### Asset Managers: Liquidity Risks
- Institutional perimeter:
  - Largest investment funds (95 percent of the industry) divided into different styles.
  - Data and baseline date: 2015Q4.
- Methodology:
  - Comparing redemptions with capacity of market for a particular asset class to be sold in an orderly manner.
  - Assuming a ranking of assets to be sold to meet redemptions.
  - Pro rata approach.
  - Redemptions applied to individual investment funds of the same style; redemptions calculated by style of investment fund as an average redemption rate across all investment funds of the same style; shock: first percentile of redemption rates’ distribution.
- Stress test horizon:
  - One quarter (shock characterized by a run on a fund represented by an assumed redemption rate).
- Risks and buffers:
  - Risk: Liquidity risk (a run on investment fund).
  - Buffers: Liquid assets, assets sold.
  - Capacity of a particular market to absorb sell-off of corresponding asset to meet redemptions (by comparing investment fund’s portfolio of a particular security with market turnover of the same security).

*Source: _cr16355 - 3. Tail shocks Scenario*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16355.pdf_