Financial Crisis and Bank Profitability

The recent turmoil in money and capital markets around the world has clearly shown the vulnerability of highly interconnected financial systems in times of recession. This paper examines the impact of the financial crisis on the profitability and risk-taking of Swedish banks. At the beginning of the crisis many banks experienced liquidity problems due to a mismatch in their funding of loans. These banks had for a number of years been financing an increasing long-term (mortgage) lending with short-term borrowing on the market. The financial crisis radically changed the risk premiums on both money and capital markets, and banks’ refinancing on these markets became extremely expensive and more or less impossible to accomplish. Without resolute intervention by the Government, issuing general banking guarantees, and the Central Bank, fuelling the market with liquidity to ever lower interest rates, the financial system might have collapsed totally. These prompt actions moved the focus from liquidity risk to credit risk. Even though Swedish banks seem to comply well with the new Basel accord (Lindblom and Willesson, 2010), three of the four largest commercial banks issued new equity in connection with the crisis in order to strengthen their capacity to absorb anticipated credit losses, primarily on the Baltic markets, in a ‘worst case scenario’.1