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Bank Leverage Holes Drive Scandinavia to Set Agenda EU Won’t

Scandinavia is once again showing it won’t wait for the European Union when it comes to banking regulation as the AAA rated region moves to curb financial industry leverage.

After beating the EU in setting rules for too-big-to-fail banks, Sweden and Denmark are now exploring the option of imposing a leverage ratio years before most of the rest of Europe does so, and with tougher limits on gearing than recommended by the Basel Committee on Banking Supervision.

Eagerness to regulate in areas neglected by the EU is growing among Europe’s richest nations, where record-low interest rates are distorting asset prices. A leverage ratio --a measure of capital to assets before they’ve been weighted for risk -- will help national regulators catch banks understating loss probabilities, said Jesper Rangvid, the head of Denmark’s government-appointed crisis commission. His report, released last week, showed excessive leverage at Danske Bank A/S almost destabilized the entire Danish economy in 2008.

“At the moment, it is difficult for the Financial Supervisory Authority,” Rangvid said in an interview. “That’s why we need some minimum level so that a bank holds a certain level of equity in the end.”

Risk Weights

Stefan Ingves, governor of the Riksbank and chairman of the Basel committee, said this month regulators in his native Sweden should target a leverage ratio before European standards are set. Ingves said in June the risk weights banks apply to their assets vary across markets, putting additional pressure on regulators to ensure capital buffers aren’t diluted. While the Swedish FSA this year required banks to raise risk weights on mortgage assets to 15 percent, the level should go as high as 35 percent, Per Jansson, a deputy governor at the Riksbank, said today.

Europe has hesitated to follow Basel’s recommendation that banks hold at least 3 percent equity relative to total assets on concern more rules risk curbing lending and hampering economic growth. The EU will instead require banks to publish their individual leverage ratios from 2015 and decide by 2018 whether region-wide standards need to be set.

Bank Freedoms

Ingves has warned that without leverage requirements, banks are left with too much freedom to lower their capital base by adjusting risk weights. Though Sweden’s four biggest banks, led by Nordea Bank AB and Svenska Handelsbanken AB (SHBA), are among Europe’s best capitalized, the lenders are “highly leveraged,” Ingves said Sept. 12.

Norway, which unlike Sweden and Denmark isn’t an EU member, is working to raise banks’ equity relative to total assets by tripling risk-weight requirements.

Dutch Finance Minister Jeroen Dijsselbloem, who leads the group of 17 euro finance ministers, said last month systemically important banks should meet a leverage ratio of at least 4 percent. He also recommends that governments be permitted to impose national standards if Europe can’t agree on a guideline. Rangvid is advising Denmark’s government against allowing banks to follow Basel’s minimum standard.

“We are simply afraid that a bank that has only 3 percent equity, that that is just low,” he said.

In Denmark, which like Sweden has watched its bank industry grow to four times its economy, Rangvid says regulators need a clear gauge of risk that isn’t subject to bank managements’ interpretation.

Danske Order

Denmark’s FSA ordered Danske in June to add 100 billion kroner ($18 billion) to its risk-weighted assets after finding flaws in its internal ratings model. Danske, Denmark’s biggest bank with assets equivalent to 182 percent of the economy, appealed the order a month later. A decision is due six to 12 months from the date the appeal was lodged, according to Danske.

Some banks already are meeting the Basel III leverage requirement, which increased the ratio from 2 percent in its Basel II standards. Ratios for large international banks climbed to 3.7 percent from 2.8 percent from 2009 to 2012, while smaller banks lifted their average ratio to 4.4 percent from 3.8 percent, according to a Bank for International Settlements survey published Sept. 15.

Among the world’s largest banks, leverage ratios range from a low of 2.5 percent at Barclays Plc to 5 percent at Bank of America Corp., according to data compiled by Bloomberg Industries.

Economic Fallout

Denmark’s banks are warning against taking the lead on yet another piece of regulation. The industry saw its funding costs surge after Denmark in 2010 became the first and only EU nation to pass a resolution framework that forces losses on senior bank creditors. Europe is still negotiating its bail-in framework.

Further extraordinary measures would put Denmark’s banks at a competitive disadvantage and risk hurting the economy, Morten Frederiksen, head of regulatory affairs at the Danish Bankers Association, said in an interview.

“Danish banks should have the same regulations as banks in other countries,” Frederiksen said. “We need to see what happens internationally, at Basel and in Europe.”

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

To contact the editors responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net; Christian Wienberg at cwienberg@bloomberg.net

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