Stability in the Financial System (2023:2): Adjustments to higher interest rates remain to be made

The Swedish financial supervisory authority, Finansinspektionen (FI), has published its latest financial stability assessment, which is published twice a year and outlines key vulnerabilities in the financial sector.
In 2023, global inflation decreased and is expected to drop further in 2024. However, uncertainty persists regarding central banks‘ actions and interest rate trends, as outlooks remain uncertain and unstable. Furthermore, high interest rates have already weakened global economic growth and have prompted adjustments in financial markets both in the value of securities and in a shift towards more stable, more secure investments.
Similarly, the high interest rates have caused several international banks to face significant issues at the start of 2023, thereby pinpointing vulnerabilities in the capital and risk management of international institutions. Although Swedish institutions weren’t directly affected, it is important to stay vigilant in this context.
Commercial real estate firms in Sweden, which typically carry a high degree of debt and thus are highly sensitive to interest rate changes, have been facing and still face significant challenges and vulnerabilities in this high interest rate environment. To avoid uncontrolled adjustments of their securities such as downgrades of debt securities or a decrease in stock value due to poor economic outlooks, these firms need to reduce their debt levels and strengthen their capital base. In this context, FI has also published new Analysis No. 41 titled „Commercial real estate firms may need to reduce their debt in which it presents its latest analysis of the local real estate sector and the risks commercial real estate firms face in view of the continuously high base rate. FI also outlines the action needed to mitigate these risks such as a reduction of debt and increase in the use of equity and / or the lowering of business engagements altogether.
Households, too, continue to experience economic strain due to the high interest rates. High debt servicing costs have been reducing financial flexibility and as many shorter-term loans come up for renewal, this strain is likely to increase even further. And although Swedish banks are currently profitable, there’s an increased risk of future credit losses due to the noted issues for companies and households.
Geopolitical uncertainty has also risen, particularly in the second half of 2023, impacting security globally. In view of the increasing digitalization and interconnectedness in the financial system, Sweden and other countries face increased risks in this context, ranging from a rise in cyber attacks, to potentially significant disruptions of critical functions resulting from high concentration on few third party service providers. It is crucial, so FI, to strengthen digital resilience among financial actors and to stay abreast of technological innovation and potential cyber threats.
Also, so FI, maturity imbalances and inefficiencies in bond markets still pose potential challenges. The government bond and covered bond markets have experienced prolonged low liquidity, which, although not yet affecting the state or banks‘ funding abilities, leaves these pivotal markets susceptible to disruptions. Similarly, corporate bond markets exhibit weak liquidity, leading to uncertain pricing and hindrances in securing financing on the primary market. This liquidity shortfall, on the other hand, elevates risks for investment funds, particularly those investing in corporate bonds. As credit ratings may suffer from low liquidity and poor outlooks, this may cause credit premiums to increase and bond prices to drop.
In conclusion, so Finansinspektionen, it is essential for all market participants, particularly commercial real estate firms, investment funds, and banks, to continue to closely monitor the development and take mitigating action whenever needed to counteract any of the noted vulnerabilities.