Do banks still benefit from an expectation of an implicit state guarantee?

News 22 January 2019

A new report from Finansinspektionen and the Swedish National Debt Office shows that the value of an implicit state guarantee for the major Swedish banks has decreased since the financial crisis in 2008–2009. This decrease is due to higher capital and liquidity requirements on the banks, a new regulation for managing banks in crisis and improved market conditions.

Historically, bank crises have often had a large impact on the financial system and the economy. As a result, market participants have expected the state to ensure that banks would survive through an implicit guarantee. This has reduced the risks for banks’ creditors, and thus has reduced funding costs for the banks in the form of lower interest rates. This interest rate discount is usually called the too-big-to-fail (TBTF) premium.

The size of the premium is determined in part by the market’s assessment of the state’s willingness to provide support to systemically important banks and in part by the probability that the need for support will arise. If the need for support does arise, the TBTF premium might increase even when the state’s willingness to provide support has not changed.

The Swedish National Debt Office and Finansinspektionen have together analysed how this premium has changed for the major banks. Since the financial crisis in 2008–2009, the premium has fallen from around 250 basis points to around 25 basis points.

More resilient banks

The reduction in the premium is due in part to the new and extensive financial regulations introduced in the EU countries after the financial crisis in 2008–2009. Stricter capital and liquidity requirements increase the banks’ capacity to carry losses. In addition, a new regulatory framework, the so-called resolution, has been introduced to manage banks in crisis. This new framework aims to protect taxpayers in that shareholders and creditors carry the losses if a bank undergoes a crisis.

Åsa David, an analyst at Finansinspektionen, and Marianna Blix Grimaldi, a senior analyst at the Swedish National Debt Office, are two of the report’s authors.

“The resolution regulation should have lowered the market’s expectations of state support for systemically important banks, while the higher capital and liquidity requirements decrease the risk of default and thus the need for state support,” say Åsa David and Marianna Blix Grimaldi.

Some uncertainty remains

Market participants appear to support this assessment, but there is still some indication that they expect state support.

“The premium may increase as uncertainty on the market increases, but most likely due to the new regulation to less of an extent than before,” assert the authors of the report.

Read the report: The value of an implicit state guarantee for systemic banks