of a significant share of total exposure to individual entities), and systematic risk, such as geographic concentration, industry concentration, and general economic volatility. Additionally, the deposit insurance scheme<sup>39</sup> and the new bank recovery and resolution framework are included in the analysis as well.

# **_Credit risk quantification_**

SNDO calculates expected losses or market values for guarantees/on-lending.<sup>40</sup> To calculate expected losses when a rating methodology has been applied to analyze a beneficiary, SNDO needs to estimate PDs and LGDs. Default probabilities are derived from the respective default rate tables of rating agencies based on historic data for similar types of entities. LGDs are also derived from rating agencies’ information on historic bond and loan recoveries. LGDs are differentiated by the bond/loan seniority stipulated in the respective agreement. If SNDO requires collateral to underwrite a guarantee/onlend, LGD estimates may be adjusted accordingly. The valuation of collateral may be outsourced to third parties. Additionally, SNDO sometimes adjusts LGD estimates based on a qualitative assessment.

If a simulation model has been used to estimate the distribution of a loss function, expected losses are inferred from the frequency of losses resulting in default. LGDs can be inferred from the severity of losses in default events.

To conduct a market value assessment, SNDO compares yields to maturity for corporate bonds and comparable government bonds. Yields of corporate bonds are taken from corporates with the same credit rating as the guarantee beneficiary’s internal credit rating as assessed by SNDO. Differences in yield hence reflect credit and liquidity premia. SNDO also studies credit default swaps (CDS) to perform market value assessments.

# **_Application in risk management_**

SNDO applies various risk mitigation tools to manage the fiscal risk stemming from exposure to credit risk from guarantees and on-lending, including guarantee fees, partial guarantee coverage, appropriations to a notional reserve account, and risk reporting.<sup>41</sup> Sweden has currently not set an aggregated limit on the flow or stock of guarantees and on-lending. However, in several cases there are annual limits set for specific agencies.

Fees charged to beneficiaries are set to cover expected costs which comprise expected losses from the guarantee/on-lending operation and administrative costs for the issuance and monitoring of the guarantee/loan. Fees are mostly charged on an annual basis. Parliament can decide to reduce or waive fees to be paid by beneficiaries. In such cases, the subsidy element must be recorded as budget expenditure and appropriated to the reserve account. In SNDO’s portfolio, about half of the exposure refers to guarantees and loans where the fee is subsidized (in part or full). In other areas, e.g. export credit guarantees, there are no such subsidies at all. In cases where European Union (EU) state aid rules apply (e.g. where beneficiaries’ operations have cross-border effects), a fee reflecting the market value of a

> 39 The deposit insurance scheme is also managed at SNDO. It is managed under the Financial Stability and Consumer Protection department, not the Guarantee and Loan department discussed in this paper.

> 40 Depending on the application of EU state aid rules discussed below.

> 41 On a case by case basis, SNDO may also incorporate the requirement to post collateral in guarantee agreements.

25 | P a g e