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The prospect of record earnings in 2023 for Sweden’s banks after robust Q3 results contrasts sharply with the potential decline in Swedish household and corporate asset quality, notably in commercial real estate. Extra pressure will come from the increase in funding costs as deposits and debt issuance become more expensive.

“Expectations for 2024 are mixed. The outlook for bank profitability and capital remains favourable, but asset quality will deteriorate and retail funding will likely contract,” says Carola Saldias, analyst in the Financial Institutions group at Scope.

On a roll: Swedish banks turn in strong results (net profit, EUR bn)

Source: Banks financial results, Scope Ratings. (*) Annualised.

Significant gains in net interest income and still contained credit impairments have underpinned recent earnings growth as operating costs have risen largely in line with inflation. The credit risk profile of banks is stable as they have comfortable capital buffers (CET 1 ratio between 16.3% - 19.4%), a balanced portfolio of mortgages and corporate loans and a diversified and cost-efficient funding structure, principally from deposits and covered bonds.

Loan volumes set for decline as broader economy struggles

“However, Sweden’s weak growth and investment outlook is set to constrain corporate loan demand,” says Saldias. The financial pressures stemming from the rise in interest rates and high inflation, as well as the economic slowdown, are reducing the needs for funding.

“We expect the Swedish economy to contract 0.7% this year after strong growth of 5.4% in 2021 and 2.6% in 2022. In addition, the corporate sector is facing further pressure from the weak krona. Registered bankruptcies are rising while the commercial real estate sector is undergoing significant restructuring and deleveraging,” she says.

For corporates, the material shift in refinancing conditions, with a more costly access to capital-markets  is a game changer – particularly for the important commercial real estate and property management sectors. Here, falling property prices and the increase in interest rates make refinancing difficult, a situation made worse by firms’ high leverage and reliance on short-term borrowing, requiring significant deleveraging and balance-sheet restructuring.

Households are also rethinking how much debt they should be shouldering. The increase in interest rates is limiting demand for mortgages, the main growth driver of retail banking in Sweden. The average mortgage rate for outstanding loans continues to increase, up at more than 3.7% in September 2023 from around 1.5% at the beginning of 2022.

In terms of funding, Swedish banks remain well positioned, with funding mostly composed of a stable and large base of deposits and covered bonds. However, the trend of a steady and cheap deposits base has reversed, which we should expect to change in H1 2024 as banks will start remunerating deposits better.

Finally, capital levels remain solid, but Scope foresees some reduction by year-end 2024, through high dividend payouts and share buybacks, as banks target a more efficient management of capital buffers.

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