Denmark won backing from the International Monetary Fund for a proposal to shield its biggest banks from bail-in legislation in place since 2010.
Recommendations by a government-appointed committee, unveiled this month, to designate Denmark’s six biggest banks as systemically important financial institutions mark a “major step forward” for the nation’s financial stability, Thomas Dorsey, the IMF’s mission chief to Denmark, said in an e-mailed response to questions.
The proposals, which will heap as much as 5 percentage points in additional capital requirements on the banks, are “an important, positive step” that helps to address “the difficulties that would have been created in attempting to apply the existing bail-in framework to even the smallest of the proposed Sifis,” Dorsey said.
Danish bail-in legislation, first enforced in 2011 with the failure of Amagerbanken A/S, sent banks’ funding costs higher as senior creditors balked at the prospect of losses. Even the nation’s biggest bank, Danske Bank A/S, was tainted by burden-sharing laws. Credit-default swaps on Danske’s senior unsecured notes trade about 50 percent higher than similar contracts on debt sold by Nordea Bank AB of Sweden, according to data compiled by Bloomberg.
The Sifi committee identified as too big to fail Danske Bank, the Danish subsidiary of Nordea Bank AB, Jyske Bank A/S, and Sydbank A/S and mortgage lenders Nykredit A/S and BRFkredit A/S. In addition to higher capital requirements, it recommended giving the Financial Supervisory Authority broader powers to step in earlier to deal with troubled banks.
The committee also recommended creating a so-called stability fund, financed by the Sifis, to enable bailouts of troubled lenders.
“It’s difficult to find any alternative to a state rescue if one of the really big financial institutions should get into trouble,” central bank Governor Lars Rohde said March 14. “That’s an issue that the report addresses.”
Denmark, the first nation in the European Union to impose bail-ins, is now acknowledging it can’t always avoid bail-outs as the rest of Europe works on legislation to protect taxpayers from bank industry losses. Weekend talks to help avert a default in Cyprus resulted in the euro zone’s first senior creditor losses.
Still, Denmark’s Sifi proposals aren’t likely to reduce the premium banks pay for funding as investors continue to price in lower government support, said Thomas Hovard, chief credit analyst at Danske Bank. Senior unsecured bondholders will continue to run a risk after the committee recommended the option of writedowns or conversion into equity in a crisis be maintained, he said.
“When a Sifi fails, it still could be wound down through a bank package three look-alike,” Hovard said, referring to the bail-in legislation. “Only from 2018, when Europe will have a bail-in framework, will Denmark be aligned with the rest of the countries.”
The EU’s latest bank resolution proposal -- one of three main pillars in a banking union that includes a single supervisory authority and common deposit insurance -- would give regulators bail-in powers by 2018. Germany, the Netherlands and Finland have argued in favor of an earlier implementation. The proposal allows national authorities to resort to taxpayer-funded bailouts after exhausting bail-in options.
The main threat to Denmark’s plans to protect its biggest banks from failure now lies in implementation, Dorsey said.
“Other authorities have found it easier to develop such plans than to get them into law and financial regulations,” he said. “The U.S. Dodd-Frank regulations were signed into law nearly three years ago, but implementation is still a work in progress.”
U.S. House lawmakers are watering down the Dodd-Frank Wall Street Reform and Consumer Protection Act amid lobbying by JP Morgan Chase & Co., Goldman Sachs Group Inc. and other U.S. banks. Denmark’s Parliament will begin a review of the Sifi committee’s recommendations next month, after a public hearing phase ends April 19.
Denmark’s opposition Conservative Party has signaled it will fight to reduce the capital buffers the Sifi committee recommended. The Danish Bankers Association is also warning the requirements will hurt the economy, which contracted 0.6 percent last year.
Danish banks’ asset quality is “much lower” than peers, the IMF said in a report released in January by the Danish central bank. The ratio of non-performing loans to the total loan book is about three times higher, the Washington-based organization said. At the same time, banks’ capital isn’t as strong as it looks, because of the nature of the instruments used and the risk weights applied to assets, it said.
“No tool can defend against all sources of risk,” Dorsey said. “But implementation of the recommendations would seem to be a major step forward.”