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Denmark’s Fight to Weaken Krone Thwarting Bank Recovery

July 5 (Bloomberg) -- 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 peg, according to Danske Bank A/S, the country’s largest lender. That would bring Denmark’s benchmark lending rate to 0.2 percent, while the rate Nationalbanken offers on seven-day 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.

Hammered Margins

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.

“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 remains in the grip of a credit crunch as loan losses erode bank earnings, Business Minister Ole Sohn said last month in an interview with newspaper Jyllands-Posten. Lawmakers in March agreed to provide at least 36 billion kroner in loans and guarantees to businesses to stem the credit squeeze.

Foreign Reserves

Denmark’s banks already are asking customers to convert their loans into mortgages as lenders 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.

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.

The central bank probably will leave the current account rate at zero, and may increase the cap on how much banks can deposit in that facility beyond its current level of 23 billion kroner, Kasper Kirkegaard, a senior currency analyst at Danske Bank, said today by phone. That would mitigate the effect of a negative certificates-of-deposit rate, he said. Only banks operating in Denmark can use the current account facility, while certificates of deposit are also accessible to foreign banks.

Krone Swings

“They’re trying to make it more expensive for foreign investors to purchase kroner by introducing a negative carry,” Kirkegaard said. “By changing the CD rate and leaving the current account rate unchanged, the bank can weaken the krone without putting too much noise into the Danish banking system.”

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. The currency yesterday weakened the most since the central bank last cut rates on May 31, and was trading at 7.4365 in Copenhagen at 11:04 a.m. local time.

To help cushion the impact of a possible rate cut on its certificates of deposit, the central bank may raise the amount that banks can hold in current accounts to as much as 200 billion kroner, Nielsen at Nordea said.

“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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