Higher Interest Rates Challenge Highly Indebted Businesses and Households in Sweden

Inflation has moderated but remains high, and several central banks have indicated that it may be a while before policy interest rates are lowered. Geopolitical uncertainties could further impact inflation and economic outlooks, leading to turbulence in financial markets. The higher interest rates also exert pressure on Swedish property companies, to which banks have significant exposures, as well as on heavily indebted households. While the Swedish financial system is generally functioning well, the risks are still elevated.

Key Points

  1. Increased Risks due to Higher Interest Rates and Geopolitical Concerns: Several central banks have signaled a delay in lowering policy interest rates. Long-term market interest rates have risen since the previous stability report, particularly in the United States, causing substantial movements in the interest rate market. The adjustment to a higher interest rate environment poses challenges, considering the extended period of low rates and rising asset prices. This sensitivity to interest rates is notable in certain sectors of the Swedish economy.
  2. Geopolitical Uncertainty: The geopolitical situation and its economic effects could pose problems. Beyond Russia’s invasion of Ukraine, conflicts in the Middle East could create turbulence in financial markets, including Swedish markets. In such a scenario, the impact on inflation and economic prospects cannot be ruled out.
  3. Property Sector Facing Challenges: Higher interest rates increase financing costs for property companies, leading to lower property values. Some companies face particularly challenging situations, while others are better positioned to handle the new interest rate environment. If rates rise further or remain at higher levels for an extended period, coupled with a slowdown in economic activity, problems for property companies could escalate. It is crucial for these companies to reduce financial risks, and banks should ensure the continued supply of credit to viable businesses while imposing requirements on property companies to mitigate financial risks.
  4. Banking Sector Resilience: Riksbank’s calculations indicate that banks have sufficient capital to manage a significant economic downturn and substantial issues in the property sector. However, calculations may not fully capture confidence effects that could impact banks’ ability and willingness to provide credit. Given the combination of risks from higher interest rates and increasing geopolitical tensions, Swedish major banks should aim to maintain a comfortable margin above formal capital requirements. This can be achieved by being cautious with dividends and share buybacks.
  5. Household Vulnerability: High indebtedness and short interest rate fixation periods make households sensitive to disruptions. Additionally, housing associations often have their debts affected by higher interest rates, leading to higher fees for members. If households struggle to cope with cost increases, leading to a sharp decrease in consumption, banks’ credit losses could rise, negatively impacting financial stability.
  6. Review of Housing Policy Needed: Riksbank suggests a comprehensive review of housing policy to ensure better functioning of the housing market and contribute to a long-term sustainable debt development. Maintaining mortgage repayment requirements and the mortgage cap is essential for sound lending practices and reinforcing a culture of repayment over time. However, some flexibility in repayment requirements is warranted to allow mortgage borrowers with specific reasons to seek exceptions.
  7. Technology Impact on Deposits: Recent banking issues in the US and Switzerland highlighted that banks can lose deposits more rapidly than previously thought. There is ongoing international discussion to investigate these issues further and potentially revise global regulatory standards for banks. In light of the challenges faced, Riksbank has conducted a detailed analysis of deposits at 24 Swedish banks, revealing varying deposit volatility, with smaller banks potentially experiencing higher volatility. Continued monitoring of deposit-related risks, particularly driven by new technology and social media, is deemed crucial.