Danish Battle to Weaken Krone Risks Undermining Bank Recovery

The Danish central bank’s battle to maintain the krone’s peg to the euro may be undermining a recovery in the Nordic country’s banking industry.

Nationalbanken probably will follow the European Central Bank today in cutting interest rates by a quarter of a percentage point to defend the krone’s peg to the euro, according to Danske Bank A/S (DANSKE), the country’s largest lender. That would bring Denmark’s benchmark lending rate to 0.2 percent, while the rate Nationalbanken offers on certificates of deposit may drop as low as minus 0.2 percent, Danske Bank said.

Governor Nils Bernstein has warned there’s no limit to the scope for deploying currency interventions and rate cuts to defend the krone’s peg to the euro. Fiscal restraint and a current account surplus have turned Denmark into a haven from Europe’s debt crisis, triggering a capital influx that Bernstein is fighting to stem. That means that banks depositing funds with the central bank now face having to pay for that privilege.

“It’s a major challenge for the financial sector,” Jan Stoerup Nielsen, a senior analyst at Nordea Bank AB, said in an interview. “It’s hard to imagine a situation where the deposit rate for households would be zero,” or one in which “you have to pay to have your money in the bank,” he said.

Burst Bubble

Denmark’s banks, which had 186 billion kroner ($31.3 billion) in deposits at the central bank as of yesterday, are struggling to emerge from a burst real estate bubble that has sent house prices plunging 25 percent since their 2007 peak. More than a dozen banks have failed since then and two thirds of the country’s regional lenders reported losses last year, leaving the industry reluctant to withdraw funds from safe central bank accounts and channel them into the economy.

Record-low central bank rates are also dragging down bank rates. While households are benefitting, lenders are struggling to make a profit. Denmark’s financial industry reported aggregate profit before tax of 3.6 billion kroner last year, compared with 39.7 billion kroner in 2007, according to figures from the Danish Financial Supervisory Authority.

“It’s a core business of the banks to attract deposits and try to make a margin on it, and that’s becoming increasingly difficult, if not impossible,” Thomas Hovard, head of credit research at Danske Bank, said in an interview.

The industry has raised fees on loans to counter declining central bank rates, raising protests among customers, Hovard said. Still, banks don’t have many options given increased regulatory demands to raise capital levels, he said.

Hammered Margins

“Building up the necessary capital buffers could be difficult,” Hovard said. “One of the ways out of the crisis is to be more profitable, and one of the ways to do that is to increase lending margins, especially when deposit margins are getting hammered.”

Alternately, banks will have to issue new shares or deleverage, Hovard said. “But from a societal point of view, deleveraging is not a good thing,” he said.

Denmark’s banks are already asking customers to convert their loans into mortgages as they look for ways to reduce capital and financing burdens. The 100 banks that offer home loans through Copenhagen-based Nykredit A/S’s subsidiary Totalkredit A/S are tapping customers’ equity to issue bonds and replace loans, said Soeren Holm, group managing director of finance at Europe’s biggest issuer of covered bonds back by home loans.

Krone Swings

Denmark’s foreign reserves climbed to a record high in June after the central bank tapped the currency market to weaken the krone. Reserves rose by 9.2 billion kroner last month to 511.6 billion kroner, the central bank said.

Denmark has an agreement with the European Central Bank to let the krone swing no more than 2.25 percent around a central rate of 7.46038, though it maintains a tighter trading band in practice.

To help cushion the impact of a rate cut on its certificates of deposit, the central bank may raise the amount that banks can hold in current accounts from 23 billion kroner to as much as 200 billion kroner, Nielsen at Nordea said. The rate can’t drop below zero.

“It’s a huge challenge,” he said. “It’s all going back to the fact that we have a peg to the euro, and we have a central bank that’s very up on defending the very narrow band.”

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net

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