Swedish Guarantee Scheme

The dual purpose of these measures was to restore confidence and encourage healthy interbank lending through the provision of liquidity (European Commission 2008). Included in the series of new programs were a new deposit guarantee program that had a higher maximum ceiling and covered all deposits, a recapitalization scheme in which the Swedish government could inject capital if a new capital investment was at least 30% private capital, and a state-backed stabilization fund to finance the interventions.

These measures formed the legal basis for the Guarantee Scheme.

As discussed in more detail below, the need to structure the Guarantee Scheme in such a way as to ensure EC approval significantly influenced the design of certain program features.

Swedish authorities subsequently reduced this amount to SEK 750 billion in connection with extending the Guarantee Scheme into 2011, given a desire to gradually phase out support to promote institutions’ return to market financing.

With the implementation of measures to support the Swedish banking sector in October of 2008, Swedish authorities established a stabilization fund to finance the program of government interventions, including any calls to honor guarantees under the Guarantee Scheme. Any support recovered from support measures would be paid back into the fund. In addition, banks and other credit institutions would be required to pay an annual stabilization fee to the fund which would be an amount proportional to the size of the institution’s balance sheet. The stabilization fund was seeded with an initial government appropriation of SEK 15 billion and was intended to amount to about 2.5 percent of GDP.

The goal of the Guarantee Scheme was to ensure the continued extension of credit to Swedish households and businesses, as well as to municipal governments. Therefore, to be eligible to participate in the Scheme, an institution had to either be incorporated in Sweden or a Swedish subsidiary of a foreign institution. In addition, firms had to demonstrate that they engaged in considerable lending on the Swedish Market (Riksgälden 2010).

In addition to being Swedish institutions active in lending to businesses and households, participating firms were required by the Swedish National Debt Office to meet certain capital requirements. The first version of the terms, passed in October 2008, called for a capital requirement of 6 percent Tier 1 capital and 9 percent combined Tier 1 and Tier 2 capital. This condition was relaxed in an amendment dated April 28, 2009, to the law, resulting in a requirement of only 8 percent combined Tier 1 and Tier 2 capital.

Coverage under the Guarantee Scheme applied only to new debt issued after the issuing institution had been approved for participation in the program by the SNDO.

Additionally, subordinated bonds, complex structured products—such as index share bonds and guaranteed equity bonds—or instruments that qualified as either Tier 1 or Tier 2 capital, were not eligible for coverage under the Guarantee Scheme (European Commission 2008).

In seeking and obtaining approval from the European Commission for the inclusion of covered bonds, Swedish authorities specifically cited the example of Denmark, where the non-inclusion of covered debt in a guarantee program was seen as resulting in the drying up of that market. With over 80% of Swedish housing loans packaged into covered bonds, Swedish authorities argued that the continued functioning of the covered bond market was essential to Sweden’s financial system as a whole. To limit the potential for distortion resulting from longer guarantees for covered bonds, Swedish authorities agreed to restrict the amount of the guarantee available for covered bonds with maturities of three years to five years to one-third the overall total, or SEK 500 billion (later reduced to SEK 250 billion with the reduction in the overall Guarantee Scheme from SEK 1500 billion to SEK 750 billion) (European Commission 2008).

Swedish authorities designated debt guaranteed under the Guarantee Scheme as eligible collateral for Riksbank liquidity facilities.

Since the Scheme was designed to help firms meet their short- and medium-term funding needs, all instruments covered under the Guarantee Scheme were of maturities between 90 days and five years. As such, it was a complement to extraordinary liquidity support measures introduced by the Riksbank. These measures initially had a maximum maturity of 90 days but were subsequently extended to one year. Initially, most debt instruments covered under the guarantee were required to have maturities between 90 days and three years; only covered bonds were permitted to have maturities extending out to five years. An April 2009 amendment to the Guarantee Scheme enabled even uncollateralized debt to have maturities greater than three years. Debt with maturities greater than three years was limited to one-third of the overall Guarantee Scheme amount.

As a practical matter, because most maturing debt was denominated in U.S. dollars and euros, these are the currencies that ended up being heavily represented among guaranteed debt.

For each financial institution, individual guarantee caps were determined and imposed according to the maximum of either:

1. The sum of that institution’s debt instruments maturing after September 1, 2008, but prior to April 30, 2009, and which had maturities longer than 90 days; OR
2. 20 percent of that institution’s public deposits as of September 1, 2008 (European Commission 2008).

The second option was added to avoid distortions between banks that had been issuing securities and those that relied solely on deposit funding.

A January 2009 amendment to the Guarantee Scheme enabled these calculations to be performed at the group level. The overall amount of guaranteed debt would remain the same as if the calculations had been performed at the level of individual institutions, but groups would have greater flexibility in how their allocations were distributed among the members of the groups.

The “Recommendations on Government Guarantees on Bank Debt,” set forth on October 20, 2008, by the European Central Bank, provided guidance on the approach to fees to be adopted by European countries introducing bank debt guarantees. Sweden’s fees were consistent with this guidance.

Fees for individual institutions were assessed according to a measure of the institution’s specific risk, plus an additional fixed amount of 50 basis points.

1. “For credit guarantees on bank debt with maturities of less than or equal to 1 year, the fee would be equal to 0.5% on an annual basis. In these cases, an assessment of the institution’s risk would not be taken into account.
2. For Credit guarantees with maturity longer than 1 year:

• For banks with CDS data, the price should equal the median 5-year CDS spread over the period 1 January 2007 to 31 August 2008 (the first criterion), plus 0.5% on an annual basis (the second criterion).
• For banks without CDS data, or representative CDS data, but with a credit rating, an equivalent CDS spread should be derived from the median value of 5-year CDS spreads during the above mentioned period for the rating category of the banks concerned, based on a representative sample of euro area large banks (the second criterion remains unchanged).
• For banks without CDS data and without a credit rating, an equivalent CDS spread should be derived from the median value of 5-year CDS spreads over the same period for the lowest rating category (the second criterion remains unchanged).
• For guarantees for covered bonds the second criterion, the add-on fee will be set to 0.25 % on an annual basis (the first criterion remains unchanged).”

This pricing structure would remain constant until April 30, 2009, but could be altered in the event that the SNDO granted an extension of the Guarantee Scheme (European Commission 2008). Per a June 2010 amendment to the Guarantee Scheme, fees were increased by 20bps to 40bps consistent with guidance from the European Commission on guarantee programs being extended beyond June 30, 2010. The purpose of this fee increase was to better reflect market conditions and to encourage participants to shift to non-guaranteed issuance as conditions allowed.

Guidance issued by the European Commission in October 2008 on the creation of credit guarantee programs called for the inclusion in programs of a set of safeguards “to minimize…distortions and the potential abuse of the preferential situations of beneficiaries brought about by a State guarantee” and “to avoid moral hazard.” This guidance did not specify exactly what safeguards a program should include but required “an adequate combination” of elements including restrictions on advertising based on the guarantee, balance sheet growth, share buybacks, and executive compensation some of which Sweden adopted.

As specified in the original terms of the Scheme, institutions were prohibited from expanding their operations beyond the pace which would have been possible prior to receiving government support. This was calculated by Swedish authorities as being the highest of:

1. The annual growth rate of Swedish nominal GDP in the previous year;
2. The average historical balance sheet growth in the Swedish banking sector from 1987 to 2007;
3. The average balance sheet growth in the EU banking sector in the prior six months (European Commission 2008).

Additionally, participation in the Scheme could not be used in the marketing of the firm.

The restriction on balance sheet growth was retracted in an amendment dated January 29, 2009, as institutions were reluctant to participate in the Scheme given the restrictions (European Commission 2009).

The Swedish Guarantee Scheme required participating firms to restrict both salary and bonus pay to the five highest-paid executives of the firm. The fixed salary pay of these individuals could not exceed the level determined prior to the announcement of the Scheme on October 20th, 2008. Variable bonus pay was entirely prohibited for the top five officers at participating firms. In addition, severance packages could not exceed the amounts prescribed for senior officers of government organizations, and board members at participating institutions could not be compensated above the levels decided prior to the announcement of the Scheme (European Commission 2008).

At first the Scheme’s issuance window was designed to be short-lived, lasting only until April 30, 2009, with the option of an extension through December 31, 2009. Through a series of amendments and extensions announced by the SNDO and approved by the European Commission in accordance with the EU State aid rules, the duration of the Scheme was extended multiple times to run through June 30, 2011. Although by 2010 and 2011 Sweden noted improvements in its institutions’ ability to secure funding without the benefit of the guarantee, the emerging sovereign debt crisis in Europe resulted in continued uncertainties. Swedish authorities viewed the extension of the Guarantee Scheme as a “stand-by insurance policy that could give banks access to medium-term financing, if conditions were to deteriorate” (European Commission 2010).