Were Swedish Banks Prepared for the Great Lockdown? Stress Testing Banks’ Capital Levels in Light of Historical Crises and Covid-19

Abstract: In modern history, Sweden has experienced two major financial crises: the early 1990s and the global financial crisis in 2008. During the last decades, there has been an increased global focus on regulating and supervising banks, where Basel III is the leading framework. Today, one of the most debated issues within the global economy is Covid-19. It is uncertain how the pandemic will affect countries’ economies and financial sectors. This paper has two major purposes. First, to examine if banks’ capital resilience has improved with the introduction of the Basel framework and Basel III in specific. Second, to examine how banks manage different scenarios of Covid-19. To accomplish this, we perform five top-down stress tests on four major banks in Sweden. Two stress tests are connected to the historical financial crises, i.e. the 1990s and the 2008 crises. Three stress tests are different scenarios of Covid-19, which vary in magnitude. In our paper, we find that banks’ capital resilience has improved. For Covid-19, we find that if the aftermath of the pandemic follows the current forecasts, banks manage the consequences of Covid-19 well. However, the forecasts are uncertain. If the aftermath is more severe than current forecasts, there is a risk that the Swedish government needs to intervene to save the banking sector.