IMF published its staff report and selected issued report in context of the 2019 Article IV consultation with Denmark. Directors welcomed the overall soundness of the banking sector and recommended a combination of micro- and macro-prudential tools to increase buffers, in addition to the countercyclical capital buffer (CCyB), if risks continue to build up. Directors considered that high household leverage amid elevated house valuations requires coordinated policy action. To reduce the identified vulnerabilities, they suggested enhancing the macro-prudential toolbox, for example, by increasing the focus on income-based macro-prudential instruments.
The staff report highlighted that the banking system remains profitable, liquid, and solvent. While profitability has decreased, it remains solid, despite slow credit growth, low interest margins, and the introduction of IFRS 9. System-wide non-performing loans remain low but vary across medium-size banks and systemically important institutions (SIFIs). The liquidity coverage ratio of Danish banks is comfortably above the current minimum requirement of 100%. Banks have ample capital buffers as confirmed by the 2018 EBA and Danish central bank stress tests. However, pockets of vulnerabilities remain. Lending surveys suggest that some banks are relaxing credit standards for corporate loans. Close interlinkages across the Nordic financial system expose banks to regional spillovers as the temporary (end-2018) increase in systemic risk measures, such as joint default probabilities of banks in the region, suggest.
The assessment shows that the financial regulatory framework in Denmark has been strengthened and additional capital buffers are being built. The Danish Financial Supervisory Authority (DFSA) completed the implementation of the final stage of the Banking Recovery and Resolution Directive (BRRD). Banks are now subject to minimum requirements for own funds and eligible liabilities (MREL) requirements, while mortgage credit institutions are exempted but must hold a debt buffer. The Systemic Risk Council recommended raising CCyB from zero to 1.5% by June 2020, amid risk build-up related to the low interest-rate environment. If risks continue to build up, a combination of micro- and macro-prudential tools should be used to increase buffers, including revisions to risk-weights, Pillar 2 requirements, SIFI and capital conservation buffers, and CCyB. To improve the calibration of tools and support financial stability surveillance, the IMF staff recommends further refining frameworks to assess systemic risk; this should include a macro-prudential stress test to quantify losses due to contagion across mortgage credit institutions, and the pension and household sectors. Extensions to estimate losses due to contagion across banks in the region should also be considered.
The housing market plays a vital role in Denmark, reinforcing macro-financial linkages. Insurance companies, pension funds, and foreign investors are among the largest holders of covered bonds, which are issued by mortgage credit institutions to fund household mortgages. In an economy with elevated house prices, rules targeting loan-to-value become less binding. Thus, increased focus on income-based measures, including debt-to-income, loan-to-income, and debt-service-to-income might be more effective to address high leverage and encourage faster amortization. A review of the efficacy of policy implementation is encouraged, including a review of institutional arrangements. Experience from other countries indicates that improvements in timeliness can be achieved by assigning independent authorities a macro-prudential mandate, which includes legal powers to implement macro-prudential policy with the corresponding transparency and accountability requirements. The Danish authorities see the macro-prudential framework as well functioning, including the timeframe for the CCyB implementation.
Keywords: Europe, Denmark, Banking, Insurance, Article IV, CCyB, LCR, MREL, Systemic Risk, Stress Testing, Macro-Prudential Policy, IMF
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