SPEECH
SVERIGES RIKSBANK
DATE: 31 May 2017
SE-103 37 Stockholm
SPEAKER: Deputy Governor Cecilia Skingsley (Brunkebergstorg 11)
VENUE: SEB, Stockholm
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
The central bank in an innovative and
fast-paced world1
On 22 July 1668, a Stockholm court sentenced a bank director to death. The bank
director's name was Johan Palmstruch, and he was the founder of the first bank in
Sweden, Stockholms Banco. A few years earlier, Stockholms Banco had suffered
an acute liquidity shortage when a confidence crisis arose regarding the
banknotes issued by the bank. When the bank was unable to pay its depositors, it
was simply taken over by the then Riksdag of the Estates, and later became the
precursor to Sveriges Riksbank. Palmstruch was thus condemned to death unless
he reimbursed the bank's creditors, which he of course was unable to do. The
Council of the Realm eventually converted the death sentence into a prison
sentence. And later, after the Chancellor Magnus Gabriel De la Gardie rushed to
the defence of the deposed banker, Palmstruch was finally granted a pardon. De
la Gardie also happened to be one of the bank's largest borrowers. It was possibly
the Chancellor's guilty conscience that made him advocate milder treatment of
Palmstruch. Not long after he was released, more precisely on 8 March 1671,
Palmstruch died of natural causes.2
A banking crisis every thirty years
With this historical retrospective, I would like to remind you that as long as there
have been banks, there have also been financial crises. And when financial crises
have arisen, the state has often had to rush to the rescue in one way or another.
In Sweden alone, severe banking crises have occurred no less than nine times in
the past 250 years.3 This entails, on average, one crisis every thirty years.
This speech is about how Sweden can counteract and mitigate the effect of such
crises, and not least the significance of having an appropriately-designed foreign
currency reserve to succeed in this. Johan Palmstruch's banknotes were an
innovation in their day, but now, 350 years later, we in Sweden are heading
towards a cashless society, primarily due to new financial technology in the
payments field. What this and some other development trends may entail for
society and for the Riksbank is the subject of my speech today.
The banks' business models entail risks
What is so special about banks that the government sometimes intervenes to
counteract banking crises? Nothing like this happens when, for instance, a
manufacturing or construction company collapses.
The reason is that a crisis in a bank can very quickly spread to the rest of the
financial system, which can in turn have very costly consequences for the
economy as a whole. I shall explain how this comes about.
The banks' traditional business model is to function as an intermediary between,
on the one hand households and companies needing credit to buy homes or to
get business projects started, and on the other hand households and companies
wanting to hold money in accounts for transactions or savings. The banks thus
help to transform savings into investment in the economy and contribute to more
efficient mediation of payments. This is of course beneficial to the economy as a
whole. At the same time, this business model entails significant risks. To put it
simply, this is because the bank's assets consist of long-term loans that cannot be
quickly and easily converted into cash, while the bank's funding is largely
shortterm and volatile. Normally, this does not entail any problems, but if for some
reason doubts were to arise with regard to the bank's ability to pay, the funding
could be withdrawn very quickly, and the bank could be forced to default on its
payments.
Problems in one bank can have serious
domino effects
As the banks are often interlinked with one another and often have similar types
of exposure, problems in one bank can very quickly have serious domino effects in
the rest of the financial system. Financial crises have arisen on many occasions
through history, and not least the extensive financial crisis the world experienced
2007-2009 reminds us that financial crises can be extremely costly and that
government measures can sometimes be necessary to stave off a total meltdown
in the economy.4 Some banks are quite simply "too-big-to-fail".
It is in the light of the banking system's inherent instability, combined with its
significance for the economy as a whole that we should regard the need for
special supervision, regulation and other measures to make the system more
robust. As I mentioned in the beginning and I shall soon develop further, this is
one reason why we need a central bank with an appropriated foreign currency
reserve.
In Palmstruch's day, it was the depositors who rushed to the bank and caused a
liquidity crisis. Unlike the 17th century, there is now in most parts of the world
some form of obligatory protection for depositors' money, a deposit guarantee.
This reduces the risk that a bank's depositors will rush off and empty their
accounts if the bank's financial strength is suddenly called into question. The fact
is that deposits from private individuals are now usually regarded as the banks'
most stable source of funding. But then we should know that the banks have for a
long time also funded themselves through short-term and volatile borrowing on
the international capital markets.5 I shall develop this a little further soon.
What is the situation in the Swedish banking
system?
The Swedish banking sector is large and cross-border. In January 2017, the
Swedish banks' balance sheet total amounted to approximately SEK 17,000 billion.
This is a figure that is rather difficult to grasp. It corresponds to four years' worth
of Swedish GDP. Everyone understands that a crisis in the Swedish banking system
can become extremely problematic and also very costly to manage.
Of course, the comparatively low sovereign debt in Sweden means we have
greater room for manoeuvre in a crisis than many other countries.
Comparatively low national debt in Sweden today
80 80
70 70
60 60
50 50
40 40
30 30
20 20
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Note. Sweden's national debt in relation to GDP, Maastricht definition. Source: Eurostat
If one looks at the Swedish banks' capital adequacy ratios as a percentage of their
risk-weighted assets, they appear to be very well-capitalised. But then one must
remember that the explanation for these capital ratios looking so good is largely
because the banks use low risk weights in their internal risk models. If one instead
looks at the non risk-weighted capital adequacy, the picture is different.
The so-called leverage ratio is almost at the same level as prior to the financial
crisis. The risk of a new financial crisis is thus certainly not eliminated, and we
should make higher demands of the banks regarding capital, so that the banking
system becomes more robust and can better withstand a crisis.
The major banks' risk-weighted capital adequacy ratios are relatively high, but
the leverage ratios are at almost the same levels as prior to the financial crisis...
Note. Per cent. The major Swedish banks' core capital ratios, Sources: The banks' interim reports and
the risk-weighted compared with non risk-weighted. Weighted average. the Riksbank
...and relatively low in an international perspective
The Swedish banks are dependent on foreign
funding.
I mentioned earlier that banks around the world are using funding from abroad to
an increasing extent. So what about the Swedish banks? Well, the Swedish
banking system's funding in foreign currency currently amounts to around 150 per
cent of GDP, which is three times as much as at the beginning of the 2000s.
The Swedish banks are dependent on foreign funding
160
140
120
100
80
60
40
20
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Note. Per cent. Swedish banking system's foreign funding in relation to GDP Source: Statistics Sweden
Foreign funding refers to Swedish banks' (including Swedish subsidiaries but
excluding foreign subsidiaries) market funding and borrowing in foreign currency.
The increase is due to Nordea's previous bank subsidiaries with effect from
the start of the year being incorporated into the Swedish parent company.
If we also include the funding in foreign currency that remains in the major
Swedish banks' foreign subsidiaries, including Nordea's mortgage lending
companies in Denmark, Norway and Finland, the funding in foreign currency
amounts to around 175 per cent of GDP, or SEK 7,650 billion.
Part of the bank's borrowing in US dollars and euros is exchanged for Swedish
krona and other Nordic currencies to finance assets in these currencies, including
lending to households and companies.6 And it is thus the banks' international
financiers, rather than the normal - protected by the deposit guarantee -
depositors who should be most disposed to withdraw their financing when the
going gets tough. If these investors stop buying the banks' bonds and certificates,
the bank may very quickly suffer liquidity problems with a high risk of being forced
to close down. This can in turn give rise to an acute threat to financial stability and
ultimately to the economy as a whole - not only in Sweden but also in our
neighbouring countries, where Swedish banks have operations.
There is a process consisting of many stages behind the lending for Swedish
mortgages and corporate loans. In this process, both the Swedish banks and their
counterparties on the foreign exchange market are dependent on the funding in
foreign currency functioning constantly.
Different currencies in the banks' balance sheets (a simplified example)
How can we then best manage the banks' increased liquidity risks in foreign
currency?
A natural starting point is that the banks - just like other private commercial
actors - should manage their liquidity risks themselves. They therefore need to
insure themselves by having enough liquidity reserves and sufficiently stable
funding in foreign currency. This reduces the risk that the government will have to
intervene in the event of a crisis. Hopefully, it also gives the authorities a little
more time to take in the whole situation and to find an appropriate solution if
problems nevertheless arise. A liquidity buffer can to some extent also be
regarded as a "deductible" that can at least on the margin reinforce the banks'
incentives to manage their liquidity risks. Finansinspektionen has also already
placed demands for how the banks should manage their liquidity risks, among
other means by requiring specific buffers in euros and US dollars. As I am sure you
know, the Riksbank's opinion is that the banks also need buffers in other
important currencies that they use in their operations.
Even if the banks were to have strong self-insurance, it is not certain that this
would be enough in a crisis situation. Then the Riksbank can act as "lender of last
resort", that is, assist the banks with liquidity if they experience difficulties
obtaining market funding. The Riksbank can in principle create any amount of
liquidity in Swedish krona. Swedish krona can normally be exchanged for foreign
currency. So what is the problem? Well, it is the word "normally" that is the snag.
In a financial crisis, there is very little that functions "normally". This is the whole
purport of the word "crisis". In other words, it is far from certain that the foreign
exchange markets will function in a crisis. And this is when it is most urgent and
most expensive to acquire foreign currency.
Swap agreements, not just a phone call
During the financial crisis, an acute shortage of US dollars arose in the banks. In
September 2008, the Riksbank was able to establish, together with some other
central banks, temporary currency loans - swap agreements7 - with the US
central bank, the Federal Reserve. However, before the agreement was signed
and ready to be put into use, the Riksbank was forced to use its own foreign
currency reserve. With the aid of this, and gradually with the new swap facility,
the Riksbank lent dollars equivalent to around SEK 200 billion for four weeks. In
total during 2008 and 2009, the Riksbank was able to offer its counterparties, with
the aid of the swap line from the United States, dollar loans corresponding to
more than SEK 1,000 billion.
Central banks' balance sheet - grown to manage financial crisis
Note. Per cent of GDP. Source: Macrobond
It is difficult to say what would have happened if the Riksbank had not received
access to the swap with the Federal Reserve, and if the Riksbank had not been
able to offer the banks this dollar facility. Probably, some of the banks would have
experienced severe difficulties. After the global financial crisis, the Federal
Reserve has announced that it no longer offers swap lines to other than a small
group of central banks, a group to which the Riksbank does not belong. It is also
highly uncertain whether we will have access to similar arrangements with the
Fed or other central banks the next time problems arise. The International
Monetary Fund, IMF, has also expressed increasing concern over this
development. In the report, the IMF calls on countries with limited currency
reserves and a lack of swap lines, like Sweden, to consider measures aimed at
strengthening their protection.8 With 70 years of experience of problems in many
countries, the IMF's advice is worth taking seriously.
Many factors contribute to Sweden's access to potential swap lines being
uncertain. The fact that Sweden is in global terms a small economy is of course
one such factor. One cannot assume that it is always in the interests of an
individual country to help another country, particularly not in cases that concern a
largely domestic crisis. The tendencies towards a more introvert policy that can be
discerned in some economies do not exactly give hope for greater helpfulness in
the future. Perhaps the conditions would be better in a global financial crisis,
when it may be in one's own best interests to help others. But the hopes of
bringing about a swap agreement could be dashed if the borrowing country's own
buffer, the foreign currency reserve, has been weakened. On the contrary, there
may be doubts that the country is capable of managing its own risks. Who would
want to come to the rescue of a country that is not prepared to pay the cost of a
reasonable insurance?
Let me make a comparison. Some years ago, Sweden chose to re prioritise within
its defence forces, and the compulsory military service system was abolished.
Now that uncertainty in global policy has increased, the Swedish defence budget
has increased, and compulsory military service is being considered again. It is
quite simply safer to have, for instance, a number of JAS fighter planes on standby
than to rely on being able to rent them if one needs them, partly because in an
acute situation it would probably take too long and because it would be difficult
and expensive.
Foreign currency reserve - part of Sweden's
economic defence
Similarly, we can regard the foreign currency reserve as part of Sweden's
economic defence. The advantage of having a foreign currency reserve is that it
can quickly be made available for liquidity support to the banking system if an
acute need were to arise.
A foreign currency reserve can also prevent a financial crisis by creating
confidence in the central bank's ability to take action when necessary. This is
particularly important in a situation where market confidence in the country's
credit and payments systems is under pressure. If you say it could never happen
to Sweden, let me remind you of Ireland and Iceland. Prior to the global financial
crisis, these countries were assessed to be in good condition with healthy public
finances and consequently high credit ratings. But in connection with the crisis,
both Ireland and Iceland suffered serious confidence crises. Their credit ratings
were cut rapidly, at the same time as their borrowing requirement was increased.
Interest expenditure soared and the countries were forced to make drastic cuts in
a number of areas of expenditure.
Swedish experiences also point to confidence falling rapidly and taking a long time
to regain. For many years after the 1990s crisis, Sweden suffered from a much
higher interest rate than Germany, with a very large risk premium on Swedish
government securities.
Given the Swedish financial system's large degree of international dependence, it
is important and necessary to maintain international confidence in the financial
system. A robust foreign currency reserve is, in my opinion, an important
condition for this. To return to the defence forces metaphor, if other countries
know that we have a number of JAS fighter planes on standby, it would probably
also reduce the risk of a conflict situation arising, where we would have to use
them.
Today, there is a proposal on the table before the Government that could in
principle entail halving the Riksbank's foreign currency reserve.9 Allowing the
foreign currency reserve to decline in a situation where the banking sector as a
whole and its funding in foreign currency are growing is to say the least a risky
venture. This is not only my opinion and the opinion of the Riksbank, it is also
shared by the International Monetary Fund. In its Article IV review of Sweden's
economy in 2016, the IMF concluded that the foreign currency reserve should not
be smaller than it is now. The European Central Bank, ECB, has also recently
issued an opinion recommending that Sweden should not reduce the size of its
foreign currency reserve below the current level.10
The foreign currency reserve should be paid
for by the banks
The cost - or insurance premium - of having a liquidity insurance in the form of a
foreign currency reserve is at present charged to the Riksbank's earnings and
central government finances and is calculated at around SEK 400-500 million a
year. This is, of course, a lot of money, but calculated per inhabitant per year the
insurance premium is only SEK 40-50. This corresponds to around two cups of
coffee or half of a cinema ticket.
Moreover, it is actually a cost that could well be transferred to the banks, which
are the primary beneficiaries of such an insurance. One could say - to take it to an
extreme - that tax-payers currently subsidise the banks by almost half a billion a
year through the liquidity insurance provided by a strong foreign currency
reserve. Depending on how the Government chose to design the charge or
premium for this insurance, it could further strengthen the incentive for the banks
to reduce their liquidity risks in foreign currency.
Financial technology has changed our means
of payment
I began by talking about Johan Palmstruch. Let me return to him now and discuss
a subject that also affects the Riksbank's ability to carry out its tasks, namely
financial innovations and the development of new financial technology, or
"FinTech" as it is known in some circles. Johan Palmstruch was a financial
innovator of his time. He was the one who introduced banknotes with
standardised denominations - a real global innovation in the 17th century. The
printing presses made it possible to mass produce these standardised banknotes.
The banknotes were much lighter and easier to transport than the heavy
copperplates that they were used to dealing with. Sweden had a copper standard
at that time.
After Stockholms Banco collapsed, it was not until the 1830s that the financial
sector in Sweden really took off. Private banking firms emerged, and some of
them began to issue their own banknotes. They continued doing so until the early
20th century, when the Riksbank was granted a monopoly on issuing banknotes
so that the state could gain a firmer grip on price stability and standardise
payments.
The development of financial technology has always been an important driving
force behind changes in the financial sector and it has often entailed new
challenges for financial stability. Now and then, it has also given central banks
reason to consider how they can best do their job.
During the latter part of the 20th century and the beginning of this one, we have
seen several innovations that have changed consumers' methods of payment.11 In
recent years, the amount of payments made with the aid of smartphones and
mobile bank ID has risen very rapidly. The Riksbank has actually contributed to the
latter by giving Bankgirot access to a special account in the Riksbank's payment
12
system RIX that enables secure payments with a mobile application.
Use of cash declining rapidly in Sweden
All of this has contributed to the volume of outstanding cash in Sweden declining
from around 10 per cent of GDP at the beginning of the 1950s to around 1.5 per
cent of GDP today. The largest decline in the use of cash has taken place in recent
years. Demand from the general public has fallen from almost SEK 100 billion in
2007 to around SEK 60 billion today.13
Banknotes and coins in circulation falling rapidly in Sweden
Source: Statistics Sweden
Note. Annual average for cash outside the banking sector, that is, cash held by
companies, households and government agencies.
One can say that the Riksbank's banknote monopoly has almost had its day, as a
number of rapid and simple electronic means of payment are being supplied by
private agencies. You see, in Sweden, there is no legal requirement for cash to be
accepted as a means of payment in the retail trade. Nor do the banks have a legal
requirement to supply cash services.
The fact that we have gained more efficient means of making payments has on
the whole been good for Sweden.
But this development also entails a number of difficult challenges, for instance,
15
that the infrastructure for cash management is being phased out in Sweden.14
Most indications are that this development will continue, which raises a number
of difficult questions: What happens if the general public no longer has access to
cash, or if it is not possible to use cash anywhere? Sweden is on the verge of a
situation where commercial interests determine whether the general public shall
have access to central bank money and ultimately what payment methods can be
used. Is there a risk that the payments market will become an oligopoly, with high
thresholds for competitors and where payment services are expensive? Can we
ensure that those who do not have access to the banks' services in the future will
still be able to manage their payments in a safe and efficient way? What would
happen in a future financial crisis, if the general public distrusts the banks and
wants to withdraw savings in cash - but the banks no longer hold cash?
Central bank money will still be needed in
the future
These important questions must be answered. In my opinion, there is reason to
examine whether the Riksbank should offer money in digital form to the general
public. If the printing press made it possible to print banknotes in its time, then
our current technology enables electronic payments. It is therefore reasonable to
try to find out whether the Riksbank can use new methods and techniques to
offer means of payment that are guaranteed by the Riksbank in the same way as
banknotes and coins.16
The Riksbank's role as supplier of liquidity in
a changing world
Technological advances and structural changes affect not only the methods of
payment, but also the risks and threats to the financial system. This means that
the authorities need to regularly evaluate and test their crisis preparedness. The
Riksbank also needs to review and maintain its liquidity tools in good shape.
Although the banks are still central to the payments system and comprise a
natural focus in the Riksbank's financial stability analysis, other agents such as
central counterparties (CCPs) are gaining increasing importance in the financial
system. Structural changes, such as the banks' funding or how they choose to
organise their cross-border operations, affect the liquidity risks in foreign
currency, among other things. This is something that the Riksbank and other
authorities must monitor.
Financial innovations such as trading robots and other types of automated
financial services can contribute to greater efficiency, but they can also give rise to
considerable liquidity stress.17 In line with technological advances, the speed at
which the transactions can be implemented is also increasing. The fact that
money and securities can, at the touch of a button, be moved immediately from
one continent to another, is something that hardly reduces the liquidity risks in
the financial system. It also emphasises the importance of central banks having
the capacity to quickly intervene if necessary. This requires having sufficient
reserves on standby.
Liquidity decisive
Let me conclude with a reflection. Many agents who have so far expressed an
opinion on the issue have emphasised Sweden's strong public finances as a
compelling reason for reducing the Riksbank's foreign currency reserve. But
everyone knows that in an uneasy situation it is always liquidity that determines
how well one copes with the problems. If you are not able to pay when the bills
fall due, those around you will lose confidence in you and ultimately you may face
seizure and bankruptcy. As a Swedish citizen and representative of Sveriges
Riksbank, it is my duty to point to the importance of good liquidity in managing a
financial crisis. This requires a foreign exchange reserve that is sufficiently large to
cover at least the foreign currency needs that may arise in the short term in a
situation of financial stress. In my opinion, such an insurance is a way of taking
responsibility that the citizens of the country have the right to require from their
government and national authorities as the world becomes faster paced and
innovation increases.
Thank you.
References
Daltung, Sonja and Mithra Ericson, 2004,"Cash-supply efficiency", Sveriges
Riksbank, Economic Review, 3/2004.
De Nederlandsche Bank, 2016, Technological innovation and the Dutch financial
sector - Opportunities and Risks for financial institutions, Amsterdam, 2016.
ECB, 2017, "Opinion of the European Central Bank of 18 May 2017 on the financial
independence of Sveriges Riksbank" (CON/2017/17).
Swedish Ministry of Finance, 2017, Riksbankens finansiella oberoende och
balansräkning (The Riksbank's financial independence and balance sheet, draft
referral to the Council on Legislation), March, 2017.
Finansinspektionen, 2017, Consultation response to the draft referral to the
Council on Legislation regarding the Riksbank's financial independence and
balance sheet, April, 2017.
Hagberg, Axel, 2007, Bankkrishantering: Aktörer, marknad och stat (managing
banking crises: actors, market and state), PhD thesis at Stockholm School of
Economics, Stockholm, 2007.
IMF, 2016a, Global Financial Stability Report, International Monetary Fund, April
2016.
IMF, 2016b, "Sweden: 2016 Article IV Consultation", Staff Report, International
Monetary Fund, November 2016.
Nilsson, Christian, Jonas Söderberg and Anders Vredin (2014), "The significance of
collective pension saving for the Swedish financial system", Sveriges Riksbank,
Economic Commentary 3/ 2014.
Reinhart, Carmen M. and Kenneth S. Rogoff, 2009, This time is different, Princeton
University, September 2009.
Sveriges Riksbank, 2017, Consultation response to the draft referral to the Council
on Legislation regarding the Riksbank's financial independence and balance sheet,
April, 2017.
Swedish National Debt Office, 2017, Consultation response to the draft referral to
the Council on Legislation regarding the Riksbank's financial independence and
balance sheet, April, 2017. Skingsley, Cecilia, 2016, "Should the Riksbank issue
ekrona?" speech at the FinTech conference in Stockholm, 16 November 2016.
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