MNI INTERVIEW: Riksbank Should Exit Bond Markets Fast-Official

The chief economist of Sweden's Financial Supervisory Authority told MNI that the Riksbank's plans to unwind its asset purchases are "a small step in the right direction" and that it should quite rapidly exit bond markets already seeing a "frenzy" of risk-taking in some sectors.

Finansinspektionen is concerned that the central bank's purchases of corporate, municipal and sovereign debt can distort prices in Sweden's relatively thin markets. Sinking spreads for bonds linked to commercial real estate (CRE) in particular signalled a danger to financial stability, FI's Henrik Braconier said in an interview.

Braconier, who has held various senior role in Sweden's Ministry of Finance, backed the use of quantitative easing at the start of the Covid crisis when turbulence was high, but with recovery underway he argues for a fairly swift reduction in the central bank's balance sheet. QE does little to support the real economy and can create stability risks by inflating property prices, he said.

"It seems like you don't get much bang for the buck in terms of actually increasing aggregate demand in the economy and inflation by subsidising higher house prices or subsidising higher CRE prices. The effect on the real economy is probably fairly weak and it is even weaker on inflation. So, given that it creates substantial stability problems, there are probably more cost-effective ways for a central bank to achieve the same sort of monetary impulse," Braconier said.

The Riksbank appears to be taking these concerns on board. On Thursday it sketched out plans to begin to decrease its stock of assets from 2023 by not fully investing the proceeds of maturing bonds. This means it could start unwinding QE before hiking rates.

LEGACY OF BANK AND PROPERTY CRASH

Banks are now far better capitalised than they were at the time of Sweden's early 1990s crisis which saw banks fail as property prices plunged, but regulators are again concerned about commercial real estate.

While banks have already been told their countercyclical capital buffer will rise to 1% and then up to 2%, Braconier said lenders are not the culprits this time round.

"What is really funding this frenzy is market-based finance," he said, pointing instead to the rapid growth in non-bank financing, fed by the Riksbank's commercial bond buying.

"If you look at the spreads they actually narrowed, they are smaller for these firms than they were before the crisis. Given that on most other measures this is a more risky sector than it was before the pandemic that points to a distortion," Braconier said.

The Riksbank needs to get out rather than add fuel to the flames, he said.

"We do think that they should get out of these markets quite rapidly, especially given the risks that we have seen in the commercial real estate sector. Because this is really feeding the frenzy in a way which is not good for stability," Braconier said.

"Even a modest increase in interest rates and decrease in revenue will push a number of these firms into potential problems, with substantial losses for the banks as well," he said.

One possible solution for the regulators would be to try and impose tougher restrictions on banks' CRE lending, through loan-to-value or loan-to-income caps or other measures, but Braconier said this could just add to the sector's demand for market-based finance.

"Bank lending to these firms rose by 5% per annum, mortgage-based finance is around 20%. So the net effect on the sector would be quite small," he said.

"If there are large losses it is probably better to have those losses to foreign investors or to bond markets. But there is clearly a trade-off. That is why we are hesitant to move in that direction," he said.