Staff Memo: The Profitability of Large Swedish Banks Exceeds Market Return Requirements

Staff memo How high are the equity costs of Swedish large banks? Dominika Krygier and Stephan Wollert June 2026

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Table of Contents 1 Profitable banks matter for financial stability 4 1.1 Profitability is important for banks' resilience 4 1.2 Profitability is influenced by many different factors 5 1.3 Swedish banks' profitability is good compared to European peers 7 2 The cost of capital can be estimated in different ways 9 2.1 Factor models and CAPM 9 2.2 Banks' estimated cost of capital is around 8 percent 15 2.3 Banks' return on equity exceeds the cost of equity 18 3 Assumptions and model choices affect results 22 4 Good profitability contributes to resilience 23 References 24 APPENDIX – Implicitly calculated cost of equity 26

Staff memo In a staff memo, employees at the Riksbank can publish qualified analyses on relevant issues. It is a civil service publication that is free from policy conclusions and individual positions on current policy issues. The publication is approved by the relevant department head. The opinions expressed in staff memos are those of the authors and should not be interpreted as the Riksbank's standpoint.

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Summary How profitable are the Swedish large banks from the perspective of the stock market's return requirements? In this analysis, we examine this by comparing the banks' return on equity with a market-based return requirement for equity. The results show that Swedish large banks have had a return on equity that, on average, has exceeded the stock market's requirements. From a financial stability perspective, this suggests that the banks have had good earning capacity relative to the risk that the stock market assesses their operations entail. This creates good conditions for the banks to absorb losses, preserve strong capital ratios, and maintain credit lending even during periods of stress. During the studied period, the banks have also been able to maintain strong capital ratios while dividends and share buybacks have been carried out. The estimates are method-dependent and sensitive to assumptions. However, two different measures both indicate that the banks' return on equity has exceeded the market's requirements, which strengthens the robustness of the results. Together, they provide a basic picture of the banks' cost of equity and can nuance the discussion about the banks' profitability. Authors: Dominika Krygier, working at the Financial Stability Department, and Stephan Wollert, formerly working at the Financial Stability Department.1 1 The authors would like to extend a big thank you to everyone who has contributed in various ways to the work on this analysis through valuable comments, discussions, and feedback. Any remaining errors and shortcomings are our own.

Profitable banks matter for financial stability 4 1 Profitable banks matter for the financial stability 1.1 Profitability is important for banks' resilience Banks' profitability is of central importance for financial stability and credit supply in the economy. Profitable banks have better conditions to meet regulatory capital requirements, to create and preserve management buffers2, to handle credit losses, and to maintain their lending to the public even in worse times. Good profitability thus contributes to strengthening the banks' ability to handle various disturbances and thereby reduces the risk that problems in the banking system have broad real economic consequences.3 In practice, banks' profitability is often measured with key figures such as ROE (return on equity), which measures the return on equity. The metric indicates how large a profit the bank generates in relation to its equity. Since the equity belongs to the shareholders, ROE can be said to show how well the bank manages the money shareholders have invested in the bank. The metric, however, gives a limited picture of what profitability means for financial stability. A high ROE can, for example, reflect that the bank has a good earning capacity, but it can also reflect that the bank takes large risks in its operations. In order to assess whether profitability is sufficient relative to risk, it therefore needs to be related to the bank's cost of equity, i.e., the return that investors require to invest in the bank's shares based on the risk that the bank's operations, and thus share ownership, are exposed to. 4 The cost of capital thus serves as a yardstick for whether the bank creates an economic surplus beyond the compensation that investors require for their risk-taking. Comparing ROE against the cost of capital is important when valuing companies in all industries but especially for banks, because risk-taking is a central part of their business model. Credit risk is a clear example. Expected credit losses are an ongoing cost that should be covered by the pricing of loans and other commitments, while unexpected losses burden the bank's own equity and should be absorbable by capital buffers. If the bank's profitability over time exceeds the cost of capital, it gets better conditions to build up capital over time. This also strengthens the bank's ability to handle unexpected losses, for example in a stressed macroeconomic scenario, without risking breaking the combined buffer requirements. How much profitability means for resilience also depends on how the profits are used. Dividends of the profit can, for example, contribute to efficient capital allocation by transferring excess capital to other parts of the economy where it can do greater good. From a stability perspective, however, good profitability gives banks the opportunity to retain part of the profit to strengthen their capital base, increase lending, adjust their management buffers to changed risks, or carry out other necessary investments. Research does not give a clear picture of the relationship between banks' profitability and financial stability. Some studies find that high and stable profitability over time can reduce systemic risks in the banking sector. This does not necessarily happen because the banks always have a higher capital level themselves, but because they then have a greater ability to generate capital and absorb losses without needing to tighten credit lending in stressed periods.5 One way to describe this is that profitability should be sustainable and function as a dynamic buffer.6 Other studies point out that periods of high profitability often coincide with more favorable financial conditions, such as low financing costs, rising asset prices, and increased risk appetite. In such environments, banks can increase their financial risk-taking, which can contribute to the buildup of cyclical systemic risks and other vulnerabilities. When macroeconomic conditions deteriorate, these vulnerabilities can materialize in the form of large losses that give rise to negative effects for both the banking system and society as a whole. 7 1.2 Profitability is influenced by many different factors Another aspect of banks' profitability is the competitive situation. If profitability is high for a long time, it can be a sign that competition is limited in the banking sector. This can give banks greater room to, for example, set lending rates to households and companies at a higher level than a market with higher competition would have allowed.8 For households and companies, this can mean higher interest expenses and worse loan conditions. In theory, high profits in a certain market should attract new players and thereby push down margins and profitability over time. But in practice, such adjustment can be hindered by structural factors such as various entry barriers, significant economies of scale and scope, and regulations that can limit new entrants, even if they are justified from a stability perspective. This can contribute to high profitability persisting for a longer time than would be expected on a market with good competition. Empirical analyses do not give a clear picture of how well-functioning competition is on the Swedish banking market compared to other countries. Some factors speak for it functioning relatively well. Sweden is assessed to have, for example, relatively high customer churn and low costs for switching banks compared to many other countries. 9 Swedish banks also have lower operating costs than banks in comparable EU countries, which can give them room to offer more competitive prices. Such factors 5 See Xu et al. (2019) and ECB (2024). 6 See speech by Claudia Buch, “Bank profitability: a mirror of the past, creating a vision for the future”, October 16, 2024, ECB. 7 See Martynova et al. (2015), Xu et al. (2019) and ECB (2024). 8 See Carletti et al. (2024). 9 See Copenhagen Economics (2025).

Profitable banks matter for financial stability 6 are generally considered to promote competition. At the same time, the Swedish banking market is concentrated to a few large players, which in combination with economies of scale can create barriers to good competition in certain product segments, for example within payment services and financial infrastructure. 10 Customer churn on, for example, the mortgage market varies between different groups. Mortgage borrowers with larger loans and higher income, for example, switch banks more often than others, while many customers who do not switch banks state that a bank switch takes too much time and effort.11 Banks' profitability is also affected by structural factors that do not necessarily depend on competition. One such factor is how their assets and liabilities are composed. Today, lending to households constitutes about two-thirds of the banks' Swedish exposures, where mortgages account for a significant share, and a large part of corporate lending consists of lending to real estate companies. Such lending, which mainly takes place with security in a property, normally implies lower expected credit losses than lending without security. This can contribute to the banks' credit losses normally being low and thus to a high reported profitability.12 But this does not necessarily mean that the banks make unusually large profits relative to the risk they take. Lower credit risk should theoretically also be reflected in lower interest margins and in a lower return requirement from investors. The financing side also has significance. Swedish banks have good access to deposits from households and companies, which is a financing source that is lacking in other industries. The deposits are typically relatively cheap and stable as a financing source and can therefore contribute to a higher net interest income. The combination of a high share of secured lending and access to deposit financing can therefore contribute to high profitability even when interest margins in, for example, lending are small. The banks' financing costs can also be affected by their special role in the financial system. If investors expect that the state may come to support systemically important banks in a crisis, it can reduce the risk premium that investors require and thereby also reduce the banks' financing costs. This can in turn affect the market's valuation of the banks and therefore also the return requirement.13 Different types of regulations are another factor that can affect banks' profitability. An example is the risk weight floor for mortgages, which means that banks must have a minimum level of capital regardless of what their internal models indicate about the actual risk in the mortgage portfolio. Such a requirement can reduce the reported return on the bank's equity, since this lending needs to be financed with more equity. At the same time, a larger share of equity means that the bank's leverage decreases, i.e., the bank needs to finance itself less with debt relative to equity. This reduces the risk for shareholders and can thereby also lower their return requirement. The risk weight floor, like other regulation, is therefore a way to make 10 See, for example, the Swedish Competition Authority (2023) and the Swedish Financial Supervisory Authority (2025). 11 See the Swedish Financial Supervisory Authority (2023). 12 In Sweden, the banks' credit losses as a share of their total lending amount to approximately 0.06 percent, which is significantly lower than the average in the EU, which stands at 0.49 percent. A larger share of loans also lacks underlying security compared to in Sweden. See Frykström et al. (2025). 13 See, for example, FSB (2021), O’Hara and Shaw (1990), Acharya et al. (2016) and FI and the Swedish National Debt Office (2019), which show that implicit state guarantees can reduce the financing costs of systemically important banks.

Profitable banks matter for financial stability 7 the banking system more resilient and where the banks themselves bear risks to a higher degree that society otherwise risks having to cover in a crisis situation. 1.3 Swedish banks' profitability is good compared to European In Chart 1, we see how return on equity (ROE) has developed for the Swedish large banks Handelsbanken, SEB, and Swedbank (left) and for selected comparison groups (right). As shown in the charts, banks' return on equity has been relatively stable for a long period and shown less variation compared to other listed companies. Since 2005, the average return on equity has amounted to around 13 percent for the Swedish large banks. Chart 1. Return on equity Percent Note. The Swedish large banks consist of Handelsbanken, SEB, and Swedbank. Nordic large banks consist of Nordea, DNB, and Danske Bank. European banks consist of an equally weighted average of the following banks: BBVA, Banco Santander, Barclays, BNP Paribas, Commerzbank, Crédit Agricole, HSBC, Erste Group Bank, Intesa Sanpaolo, Lloyds, KBC Group, RBS, Société Générale, UBS, and UniCredit. Refers to four-quarter rolling averages. Sources: The banks' quarterly reports, Bloomberg, and Macrobond. In recent years, the Swedish large banks' return on equity has been around 15 percent, but it has gradually decreased since 2024. From a historical perspective, however, the return is still high. The single most important explanation for the high profitability in recent years is rising net interest income in connection with the interest rate increase in 2023. Swedish banks have a large share of lending with variable interest rates, which means that higher market interest rates quickly pass through to their interest income. At the same time, deposit interest rates are often raised more slowly than lending rates, which means that interest margins can increase quickly. Since net interest income is the largest revenue source for Swedish banks, this development has had a large impact on profits.

Profitable banks matter for financial stability 8 The higher profitability in recent years should also be seen against the background of the long period of low interest rates that preceded the interest rate increase. Low interest rates certainly pressed the banks' interest margins but simultaneously contributed to high demand for credits and thus to growth in the lending portfolios. When interest rates then rose, the net interest income improved quickly while credit losses remained low. The Swedish large banks have also, for a long time, limited cost development, which has improved the relationship between costs and revenues (expressed through the so-called C/I ratio) and strengthened profitability. Compared to other banks in Europe and the Nordic countries, Swedish banks have a higher return on equity on average. One explanation is that Swedish banks generally have lower costs relative to their revenues than banks in other European countries. European banks have and have also had a higher share of so-called problem loans on average. This means, in addition to missed interest income, also increased costs in the form of asset write-downs and therefore larger credit losses, which further press down profitability. In addition, many European banks are characterized by weak revenue diversification, where the dependence on traditional interest income is large while revenues from, for example, fees and asset management are more limited. These factors are reinforced by the fact that competition is high in several European countries.14 Structure of the analysis In this staff memo, we examine how the observed profitability of the Swedish large banks relates to a market-based return requirement for equity. The return requirement, which can also be described as the bank's cost of equity, is estimated on an annual basis using two different methods. The analysis begins with a description of how the return requirement, i.e., the cost of capital, can be estimated using different models. We then perform the estimation and compare it with the banks' actual profitability. The results are finally related to the banks' profits through a so-called residual profit analysis. In this part, we divide the profits into a part that corresponds to the cost of equity and a part that exceeds this. The latter part is named residual profits. The analysis thus gives a stock market-based perspective on the banks' profitability and should be seen as a complement to other assessments of the banks' resilience. 14 See Financial Stability Review, November 2019, European Central Bank.

The cost of capital can be estimated in different ways 9 2 The cost of capital can be estimated in different ways To assess whether a bank's profitability, measured as return on equity, is in reasonable proportion to the risk it takes, a reference point is required for what can be assessed as a normal or market-motivated return. Such a point is the cost of capital for equity (cost of equity), i.e., the return requirement that investors can be assumed to set based on the bank's risk profile. Unlike the cost of capital for debt (cost of debt), which to a large extent can be observed directly through the banks' financing costs, the cost of capital for equity is not directly observable but must be estimated. Below, one of the most fundamental methods for estimating it is presented. In the appendix, an alternative used in the analysis as a complement is presented. 2.1 Factor models and CAPM A very common way to estimate the cost of capital is to use so-called factor models. Fundamentally, these models are based on Markowitz's (1952) portfolio theory, where investors are assumed to require higher expected returns to bear higher risk. In factor models, the focus is on systematic, or non-diversifiable, risk. This is the type of risk that is common to many or all assets on the market, for example, business cycle fluctuations or changes in interest rates. Unlike unsystematic risk, which is specific to a certain type of company or industry, systematic risk cannot be diversified away by spreading investments over several assets. To measure how sensitive a single asset is to systematic risk, it is examined how its return covaries with one or more risk factors. This is called the asset's factor exposures. In practice, the factor exposures are estimated through a statistical analysis, often with a regression, where the asset's return is related to the return on one or more risk factors. Each risk factor also has a risk premium. This can be interpreted as the extra return, beyond the risk-free rate, that investors require to bear just a specific type of risk. Together, the factor exposures and risk premiums determine the expected return and thus the cost of capital for the banks' equity. One of the simplest factor models is the single-factor model Capital Asset Pricing Model (CAPM), developed by Sharpe (1964), Lintner (1965), and Mossin (1966). According to CAPM, an asset's expected return is determined by the risk-free rate plus a risk premium that depends on the asset's exposure to the common market risk. This exposure is measured with beta, which captures how sensitive the asset's return is to movements in the market portfolio. A higher beta means that the asset has higher systematic risk and therefore should also give a higher expected return, or have a higher return requirement. According to CAPM, an asset's, i, expected return is determined as follows: E(r_i) = r_f + β_i(E(r_m) - r_f) (1)

The cost of capital can be estimated in different ways 10 where r_f represents the risk-free rate, β_i is the beta value for the current asset i relative to the reference index, and E(r_m) - r_f represents the expected market risk premium. The asset's expected return, and thus the cost of capital for equity, is a linear function of its systematic risk (market risk in the case of CAPM). The higher the beta value, the more sensitive the asset's return is to market movements and the higher the return investors should require to bear this risk. To use expression (1), a number of input parameters are required. First, a risk-free rate is needed that should reflect the return investors can get on an alternative placement with no or at least very low risk. Second, an estimate of the market portfolio's expected return is required, which determines the market's risk premium together with the risk-free rate. Third, a measure of the asset's beta is required, which measures how sensitive the asset's return is to movements in the market portfolio's value and thereby determines how large a part of the market risk premium should be included in the return requirement for the individual asset. The next section describes each of these components.15 Determination of the risk-free rate There is no predetermined choice of risk-free rate when calculating the return requirement. In the literature, both short and long-term government bond rates occur, as well as various forms of normalized reference rates. Empirical studies of market practice, however, show that the ten-year Swedish government bond rate is the most common choice among Swedish investors (see Chart 2).16 In this analysis, therefore, the ten-year Swedish government bond rate is used as a measure of the risk-free rate. 15 For a more detailed review of CAPM and its limitations, see, for example, Fama and French (2004) or Chen et al. (2022). 16 According to PwC's Risk Premium Study 2025, more than 70 percent of respondents in the survey use the 10-year Swedish government bond rate as the risk-free rate, while the rest mainly use the 5-year government bond rate or a normalized rate.

The cost of capital can be estimated in different ways 11 Chart 2. Choice of risk-free rate for calculating the return requirement and Swedish government bond rates Share of respondents, percent Note. Left chart refers to the share of market actors who choose a certain rate as the risk-free rate. Participants in the survey are asset managers, venture capitalists, fund brokers, and advisors within corporate finance. Right chart refers to benchmark bonds. The maturities can thus vary periodically. Sources: PwC's Risk Premium Study (2012–2025) and Macrobond. Determination of the market risk premium