UPDATE 3-Swedish watchdog toughens bank mortgage rules
* FSA proposes 15 pct mortgage risk-weight floor
* Says Swedish banks exposed to mortgage risks
* Proposed rules will bring banks in line with Europe
* Nordic bank shares outperform index (Adds Moody's statement, updates shares)
By Mia Shanley and Johan Ahlander
STOCKHOLM, Nov 26 (Reuters) - Sweden's banks need to more than double their capital buffers against mortgage lending risk, the industry regulator said on Monday as it tries to safeguard an over-sized financial system.
Dominated by Nordea, Handelsbanken, SEB and Swedbank, the banking sector's assets are more than four times the size of economic output and regulators want to reduce the potential for future financial crises.
The mortgage proposal from one of Europe's toughest regulators came as ratings agency Moody's upgraded its outlook for Swedish banks to stable from negative citing strong asset quality, high capital and healthy profitability.
Conversely, rival agency Standard & Poor's cut its outlook to negative from stable last week.
The Financial Supervisory Authority (FSA) said it wanted banks to use a 15 percent risk-weight floor for mortgages. The capital buffers which banks have are calculated using different risk-weights for different kinds of loans.
"Swedish banks are substantially exposed to risks in Swedish mortgages," the FSA said. "The forthcoming requirements will bring about a more stable financial system which will in turn generate positive effects on the economy."
Banks have for years suffered low loan losses in mortgages and have therefore used single-digit average risk-weights on such loans.
But Swedish household debt has risen to 170 percent of disposal income, one of the highest in Europe.
The banks currently set aside less capital for losses from mortgages than peers - around 6 percent on average versus around 25 percent in Europe - according to the central bank.
The FSA said it believed that banks already had the funds to increase capital buffers, meaning they would not need to raise money.
Swedish banks are some of Europe's best capitalised lenders, but regulators see them as being vulnerable due to a reliance on market funding and extensive international operations.
However, Moody's said the Swedish economy had outperformed most of the euro zone, helping to insulate its banks from the debt problems plaguing other parts of Europe. It said an economic slowdown would not likely materially hit banks' asset quality.
"We expect loan repayment capabilities will continue to be supported by low interest rates and households' resilient financial profiles," it said.
Nordea, the region's biggest bank, backed the risk-weight proposal. "This has to do with investor confidence," said Rodney Alfven, head of investor relations. "We support the basic idea."
Swedbank, one of Sweden's biggest mortgage lenders and the bank whose core tier one capital ratio will be most affected, said the guidelines were reasonable.
It has previously said a 15 percent risk-weight would reduce its core tier one ratio by 2.3 percentage points.
Nordic bank shares were down 0.3 percent by 1430 GMT, outperforming a European banking index, which was down 1.2 percent. Swedbank shares, which had been under pressure due to uncertainty over the rules, were up 0.9 percent.
"Although it was in line with expectations, this is still important. This was the final piece in the capitalisation debate," said Andreas Hakansson, an Exane BNP Paribas analyst.
Changes to risk-weightings completes a slew of new rules that have made life tougher for Swedish lenders.
Sweden has already asked its lenders to hold 12 percent core capital by 2015, a higher level than most other countries, and banks have boosted balance sheets by cutting risky lending and building up capital. That has raised costs but also made them some of Europe's safest, most attractive lenders for investors. (Additional reporting by Oskar von Bahr; Editing by Erica Billingham)