Riksbank at odds with proposals to limit capital, analysts say

Proposals to limit the capital that can be held on Sveriges Riksbank's balance sheet were met with scepticism today, as Swedish analysts suggested they clashed with the central bank's desire to hold adequate reserves.

The proposals, commissioned by Sweden's ministry of finance and released on January 30, suggested decreasing the Riksbank's capital from its current level of 415 billion krona ($65 billion) to 200 billion krona ($31.4 billion), not including Sweden's loan to the IMF of up to 180 billion krona.

According to the proposals, the Riksbank cannot know how much foreign currency it would need to hold in advance of a crisis and, with the appropriate framework in place, would be better off sourcing the funds as and when financial stress occurs.

The proposals attempt to strike a balance between the competing objectives of ensuring the Riksbank has enough reserves to ensure financial stability, while minimising the opportunity cost of it holding capital on its balance sheet.

The proposals would free 215 billion krona of capital that is currently "tied up in the Riksbank", and would be transferred to the government. In normal times, this surplus would be around 90 billion krona, which if released would mean between 180-270 million krona ($28 -43 million) for the government.

The commission proposes that the Riksbank is allocated 75 billion krona ($11.8 billion) in interest-free capital, made up of 30 billion krona in equity capital, and the rest in banknotes and coins currently in circulation. It would be permitted to hold additional foreign currency reserves, up to the point where its interest free and borrowed capital totalled 200 billion krona ($31.4 billion).

Should the central bank need to use its foreign currency reserve to provide emergency liquidity assistance, it would be allowed to replenish them by borrowing from the Swedish Debt Office, thereby ensuring a (theoretically) limitless supply of funding. The debt office would raise funds by issuing government bonds.

Claes Måhlén, the chief strategist at Handelsbanken, said the Riksbank is concerned about how strong the market demand for such bonds would be in times of stress. "Even though Sweden has a triple-A rating and the demand for debt has been quite high that may change rapidly," he said. "Especially if the market knows the money is being given to struggling banks, then the price for that money may be very high. It may not even be supplied, in a Lehman-like situation."

Måhlén suggested the Riksbank prizes the security of holding dollars on its balance sheet and the certainty that it will be able to fund banks. "The Riksbank is more risk-averse in this sense," he said.

Knut Hallberg, a senior economist at Swedbank, said he found the proposals to be "a little bit lacking". The last couple of years, he said, have shown that the Swedish central bank needs to hold much larger currency reserves than was earlier thought.

As the Riksbank does not have a swap line with the Fed, it should hold enough reserves to supply dollars to banks in the event of a liquidity squeeze, Hallberg explained.

Both Måhlén and Hallberg said it was quite unlikely the proposals would be implemented, at least in the short-term.

Were the proposals to pass, Måhlén suggested they would undermine Riksbank governor Stefan Ingves, whose primary expertise is in financial stability - he is chairman of the Basel Committee on Banking Supervision - and to see his experience dismissed would be a hard blow. "I'm not even sure he could stay on after such a decision," Måhlén said.