Back in 2006 we made the first stress test based on a possible worse development in the Baltic region and noted that if this were to occur, the banks’ resilience would deteriorate and their scope to manage other negative shocks would be reduced. The Riksbank’s Deputy Governor Lars Nyberg informed the board of Finansinspektionen (the Swedish financial supervisory authority) of his fears regarding developments in the Baltic. Mr. Nyberg raised the issue in Finansinspektionen, in the summer of 2008, that the capital adequacy requirement for Swedish-owned banks with operations in the Baltic region should be raised to compensate for the higher risk. However, the board concluded that bank groups’ capital already exceeded the legal minimums on a consolidated, group-wide, basis and thus the parent bank could transfer part of its excess capital to a subsidiary in the Baltic countries, if necessary. Hence, no further measures were required. The Riksbank has regularly informed the Swedish banks of our assessment of risk in the Baltic countries. We have also required that the banks send us supplementary information so we can analyse the potential risks in greater detail. In addition, together with Finansinspektionen we have visited the banks’ subsidiaries and branches in the Baltic countries to study in detail, for instance, their loan management. The Riksbank has for several years now carried out regular crisis management exercises regarding financial crises. In 2007 a crisis management exercise was held together with all of the Nordic and Baltic countries, where the scenario involved a crisis in a cross-border Nordic bank.

However, with regard to leveraged finance, risk managers find it difficult to appropriately and effectively play their role in a market environment characterised by fierce competition. More specifically, there are three areas where we are currently pushing for improvement. First, with regard to procedure, historical credit norms are beginning to weaken and more market-friendly structures have been adopted – I already mentioned the covenant-lite issue. In that regard, the thorniest aspect is the credit approval process. The speed of credit approval has become a cornerstone of competitiveness in the market for leveraged finance. In order to increase their market share, banks have significantly shortened their internal validation process. Anecdotal evidence suggests that many deals are presented by the borrowers as “take it or leave it”. In some cases, potential borrowers requested approval within 48 hours. To me, it seems rather challenging to properly understand a deal within 48 hours – both for the front office as well as for risk management. Second, with regard to limits, risk managers need to be alert regarding a shift towards structures that support an expanding business. Most banks have limits in place with regard to exposures held on their own books. However, these limits have sometimes been shifted upwards to accommodate business needs and the prospect of rewarding transactions; the underwriting limit, for instance, has on average increased by 49% between 2012 and 2014. In such circumstances, risk managers should ensure that stress tests adequately reflect the higher limits.