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Banking Regulator Reveals New Rules for Capital Adequacy
In a surprise move, Sweden’s Financial Supervisory Authority (SFSA) has announced that Tier 2 instruments will now rank ahead of Tier 1 instruments in terms of capital adequacy, but will be subordinate to unsecured senior debt. The news comes as the banking regulator continues to implement new rules aimed at ensuring financial stability and preventing future crises.
Revised Guidelines for Capital Adequacy
Under the revised guidelines, banks must maintain a minimum capital ratio of 8%, with breaches potentially leading to the withdrawal of a bank’s license. However, the SFSA has also introduced various capital buffers designed to provide an additional layer of protection against systemic risks. These buffers include:
- The capital conservation buffer
- Institution-specific countercyclical capital buffer
- Systemic risk buffer
- Buffers for systemically important institutions
While the buffer requirements are not binding in the same way as the minimum 8% ratio, a breach can still lead to restrictions on dividend payments. The SFSA is also empowered to impose additional capital requirements, known as pillar 2 capital, if it deems necessary.
Leverage Ratio and Enforcement Strategy
In addition to these changes, the SFSA has emphasized the importance of a leverage ratio, which measures a bank’s Tier 1 capital against non-risk-weighted assets. While currently only a pillar 2 provision in Sweden, the proposed revisions to the CRR-CRD include a binding leverage ratio of 3%.
The regulator has also outlined its enforcement strategy, including:
- Regular capital adequacy reports from banks
- Ad hoc investigations as necessary
Consequences of Undercapitalization
In the event of undercapitalization, a bank may be required to implement measures to remedy the situation, such as reducing exposures or implementing parts of its recovery plan. If a breach occurs, restrictions on dividend payments will apply, and the SFSA may impose supervisory actions, including orders to reduce exposures.
If a bank’s financial position continues to deteriorate, contractual write-downs and/or conversions of capital instruments may occur, and the SFSA could also decide to write down or convert certain debt instruments. Ultimately, the bank may be subject to resolution actions or its license revoked, leading to mandatory liquidation or bankruptcy procedures.
Recent and Future Changes
The capital adequacy framework has undergone significant revisions in recent years, with a further revision adopted by the European Commission in 2016. The proposed changes include:
- More risk-sensitive capital requirements
- A binding leverage ratio
- New requirements to address excessive reliance on short-term wholesale funding and reduce long-term funding risks
Foreign Ownership and Controlling Entities
There are no restrictions on foreign ownership of banks in Sweden, allowing international investors to participate in the country’s financial sector.
Entities controlling banks must ensure that they meet the SFSA’s criteria for significant influence over the management of the bank. This includes:
- Reviewing the entity’s reputation and financial strength
- Potential connections to money laundering or other financial crimes
In the event of insolvency, shareholders may be liable for any losses incurred by the company, provided they have acted with intent or gross negligence. The SFSA also has the power to reduce share capital, potentially incurring losses on direct shareholders.
Conclusion
The revised capital adequacy rules are designed to promote financial stability and ensure that Swedish banks are better equipped to withstand future economic shocks. As the regulatory landscape continues to evolve, it remains to be seen how these changes will impact the country’s banking sector.