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Danske Bank Trading Gain Provokes Regulator Reprimand

Danske Bank A/S said the financial regulator decided to reprimand Denmark’s biggest bank over its risk controls because of a surge in revenue at its trading unit.

Net trading income climbed 34 percent from 2007 to 10.6 billion kroner ($1.9 billion) last year, according to the Copenhagen-based bank. Income from trading grew 21 percent last quarter from the first three months of 2013, Danske said Aug. 1. After net interest income, revenue from trading securities made the biggest contribution to Danske’s total income last year.

“We can see that we have had huge profits in our market activities that would spark interest in how we manage our market risks,” Peter Rostrup-Nielsen, Danske’s chief risk officer, said in an interview.

The Financial Supervisory Authority said this week that Danske, whose assets are almost twice Denmark’s gross domestic product, needs to improve the transparency around its value-at-risk models -- a measure of how much a bank stands to lose within a given time frame. The reprimand follows questions in the U.S. about the ability of VaR to predict risks after JPMorgan Chase & Co. failed to prevent a $6.2 billion trading loss.

Danske Bank “has had in a few short years very large profits from activities with a market risk, also in comparison to peers,” the FSA said on Aug. 27. “The bank shall ensure that the validation of models of market risk are sufficiently independent of the models’ development.”

‘Attracts Attention’

Danske has “had significant income in our trading area, but that does not necessarily mean that it was driven by taking excessive risks,” Rostrup-Nielsen said. “We don’t feel that is the case. But of course it attracts attention to see whether our risk management is appropriate.”

The financial regulator’s reprimand follows an order in June that Danske add $18 billion to its risk-weighted assets amid concern the bank was understating its credit risks.

Danske, identified by a government panel as one of Denmark’s too-big-to-fail banks in March, reported a 46 percent jump in second-quarter net income earlier this month as impairments dropped by almost half. The bank said its solvency need was 11.3 percent, up from 11 percent three months earlier.

The Copenhagen-based agency told Danske to improve its market risk controls after reviewing a study on the bank’s risk management systems. The review was paid for by Danske after being requested by Denmark’s 14-member Financial Council, which advises the FSA on key cases. The FSA said it received the analysis, conducted by the consulting firm Oliver Wyman, on June 18.

Mirroring Reality

The review, which was supposed to determine whether Danske had taken on more risk than it budgeted for and whether its assessments mirrored reality, found Danske’s systems were generally adequate, with areas for improvement, the FSA said.

Regulators across the globe have been taking a closer look at how institutions use VaR after JPMorgan trader Bruno Iksil, nicknamed the London Whale, took positions that grew too large for him to unwind without incurring billions in losses.

When Iksil ran up against a VaR cap, rather than curb his trading, JPMorgan changed its model, according to documents compiled by the U.S. Senate’s Permanent Subcommittee on Investigations, which earlier this year concluded a nine-month review. The bank’s shares plunged and its chief investment officer was fired.


Danske’s implementation of VaR, the safeguards the bank already has in place, and products traders deal rule out the possibility of a JPMorgan-style loss, Rostrup-Nielsen said.

“We don’t have the profit-loss part of the organization managing their own risks,” he said. Danske does “more plain vanilla business,” trading conventional products such as interest rates and foreign currencies, and as a result, “it is much more transparent what the risks are,” he said.

Danske’s daily VaR averaged 235 million kroner in the second quarter, the highest level in a year, the bank said earlier this month. Rostrup-Nielsen declined to disclose what the bank’s VaR budget is, saying the figure isn’t public.

Trading income “has been fairly high at times throughout the financial crisis because spreads have been wider and activity levels have been higher, so trading conditions in some aspects have been better,” Rostrup-Nielsen said. “If you look at the risk numbers, they have been fairly stable throughout so it hasn’t been a result of us taking a one-sided bet on the market.”

Tougher Oversight

The FSA has toughened its oversight of the financial industry since Denmark’s property bubble burst in 2008. Spar Nord Bank A/S said today an inspection found Denmark’s fourth-biggest listed lender had correctly stated losses. Similar inspections at smaller community banks since last year led the regulator to conclude bad loans were big enough in some cases to wipe out equity. Toender Bank A/S, a regional lender close to the German border, was declared insolvent after a November inspection.

Danske said it will hire an external consultant to review its VaR models. It has already boosted capital by 300 million kroner as a buffer against potential losses from credit spreads.

“There is nothing there that is too surprising,” Rostrup-Nielsen said. “In some areas, we were already making progress.”

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