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June 20, 2018

IMF published its staff report and selected issues report in the context of the 2018 Article IV consultation with Denmark. The assessment reveals that banks are well-capitalized and progress was made with upgrading the regulatory framework. Banks remain profitable notwithstanding low interest rates and modest aggregate credit growth. Additional increases of the countercyclical capital buffer (CCyB) may be warranted if risks continue building up. Moreover, the operational independence of the Danish Financial Supervisory Authority (DFSA) should be strengthened and adequate resources should be ensured for continued effectiveness.

The staff report reveals that the financial system is robust and signs of increased risk-taking have emerged. System-wide nonperforming loans are low, although arrears for medium-sized banks are considerably higher than for systemically important financial institutions (SIFIs). Liquidity requirements, such as the liquidity coverage ratio, are comfortably met, with a proposal for treating mortgage credit institutions’ (MCIs) covered bonds as stable funding for purposes of the net stable funding ratio (NSFR) under negotiation. Banks are adequately capitalized, but, in early 2018, DFSA issued a public warning against excessively low IRB risk-weights for mortgages in high-growth areas. Recent stress tests by the central bank reveal the potential for a capital shortfall for some SIFIs. The pension and insurance firms have adjusted their business models to the low interest rates by promoting more market-based products over guaranteed-return products.

Additional capital and resolution buffer requirements are set to take effect in the next few years. The government approved the activation of the CCyB to .5% of risk-weighted assets from March 2019. Implementation of the Basel III minimum risk-weights is estimated to increase capital requirements for Danish SIFIs by DKK 78 billion (almost 5% of total risk-weighted assets) or 34% higher than the previously-planned fully loaded capital. Additionally, DFSA completed the final stage of the Banking Recovery and Resolution Directive (BRRD), by setting minimum requirements for own funds and eligible liabilities (MREL) and the resolution strategy for all financial institutions from July 01, 2019. Single-point-of-entry resolution for SIFI groups was granted, but MCIs continue to be exempt from the bail-in central resolution tool and MREL. Instead, SIFIs are subject to a debt buffer requirement in line with the Single Resolution Board’s recommendation for a minimum 8% of Total Liabilities and Own Funds (TLOF). An outstanding item is to finalize the debt buffer requirement and resolution strategies for Nykredit, the largest mortgage lender, and DLR Kredit.

Staff recommended further policies to strengthen the financial system. The treatment of mortgage covered bonds for the definition of NSFR should be consistent with long-term funding stability, irrespective of market access. Staff supports the Systemic Risk Council’s broad information approach to assess systemic risk and set the CCyB. If risks continue to build up, additional increases of the CCyB would be important to enhance financial resilience. Staff recommended to continue developing key indicators to assess systemic risk, possibly including macro-prudential stress tests to quantify losses due to systemic risk amplification owing to cross-sectoral and/or regional contagion. The authorities expect credit institutions to meet capital requirements under Basel III rules and maintain adequate funding. The government agreed on the importance of maintaining strong bank supervision but did not see the need for lengthening the term of DFSA board membership. A new Memorandum of Understanding with Nordic counterparts was signed in February 2018 to lay out coordination and cooperation principles for the exchange of information on resolution issues. The authorities conducted a review of the MOUs with Nordic-Baltic counterparts, which they believe should promote effective oversight of systemic banking groups in the region. The operational independence of DFSA should be strengthened and adequate resources should be ensured for continued effectiveness.

The selected issues report examines the determinants of investment slowdown in Denmark, along with its policy implications. It also analyzes the role of asset prices in households, pension funds, and credit institutions. The report emphasizes that the application of macro-prudential policy measures may also need to be considered in light of potential vulnerabilities for some households-at-risk.

 

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Keywords: Europe, Denmark, Banking, Article IV, Basel III, BRRD, Resolution Planning, CCyB, IMF

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