MNI INTERVIEW: SEK Bond Liquidity In Doubt In Crisis-Regulator

--Finansinspektionen (FI) Director, Chief Economist Braconier On Spreading Risks

Of Low-for-Long

--Braconier Says Question Is Whether Government Bond Market Will Be Liquid In

Crisis

--Braconier Highlighs Problem Of Insurers, Pension Funds Using Averages of Past

Interest Rates

By David Robinson

     LONDON (MNI) - There are doubts over whether Sweden's government bond

market, sapped by central bank asset purchases, would remain liquid in a

financial crisis, Henrik Braconier, Chief Economist and Executive Director at

the Swedish financial regulator Finansinspektionen (FI), told MNI.

     The Riksbank quantitative easing has left it holding around 40% percent of

outstanding Swedish krona-denominated government bonds with two-fifths of

participants in the Riksbank's latest survey saying the sovereign debt market

functions poorly.

     "The situation seems to have improved a bit but whether it is really good,

that is another question," Braconier said in an interview. "The key question is

how liquid will it be some time in a future crisis? That is the big question."

     In its stability report Nov. 28, the Riksbank pointed to widespread

distortions caused by low rates and easy monetary policy, including a trend for

insurance companies to invest in more illiquid assets such as real estate and

for heavier investment in corporate bonds with lower credit ratings. 

     The lack of liquidity in Swedish government bond markets, as well as the

lack of depth and longevity in local swaps, compounds these trends, by failing

to provide references for discounting insurance companies' liabilities. Instead

insurers discount liabilities using a synthetic Ultimate Forward Rate, which is

based on a long-term average of observed real rates.

     There is a risk the current UFR rate will turn out to be artificially high,

if real rates remain below historic averages. Insurers have to take this into

account, Braconier said.

     "We are not saying we should change the system in terms of moving to market

rates but we are rather saying 'You know, you have a challenge here and you had

better address it' and the best way to do that is to be prudent right now, to

make sure that you have a balance between what kind of return you can get on

your assets and what you promised future pensioners," he said.

     --BANK PROFITABILITY 

     FI's message to firms is "to make sure that you maintain sufficient capital

buffers within the firm in order to be able to withstand it if we were to live

in this future, quite bleak, scenario," he said.

     Low interest rates have also fuelled real estate lending, with about 65% of

loans made by the big three Swedish banking groups having a property component.

     What is unclear is whether overall risk taking is increasing or holding

steady at relatively elevated levels.

     "This is an area where it is difficult to get very precise high frequency

data," Braconier said, adding that officials' view has remained broadly the same

for the past six months.

     "Prolonged, or low-for-ever (interest rates) .. continue to be a risk

driver."

     But while negative interest rates have sowed risks throughout the financial

system, they have not done much damage to Swedish banks' profitability, in part

because lenders have been able to fund themselves on bond markets rather than

relying on deposits.

     The Riksbank first set a negative repo rate, of -0.10%, in February 2015,

and it has been below zero since.

     Research on the Swedish banking sector by former US Treasury Secretary

Larry Summers and economist Gauti Eggertsson suggested that setting a negative

policy rate reduced bank profits as deposit rates could not follow the policy

rate down. Braconier, however, noted that the gap between banks' deposit and

lending rates is only part of the story.

     "It is not like we are saying it can't have an effect, or shouldn't have an

effect. But profitability continues to remain high in this environment," he

said, adding that "Sweden is in a better position than many other countries in

that respect."

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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