Dec. 12 (Bloomberg) -- Danish central bank Governor Lars Rohde said a potential liquidity shock that would follow curbs on banks’ use of covered bonds would be manageable for the industry.
Danish lenders have been holding crisis talks since it emerged last month that the European Banking Authority is planning to recommend covered bonds not be given the highest liquidity designation. Banks hold about 34 percent of Denmark’s $530 billion mortgage-backed covered bond market, the world’s largest per capita, and the industry warns the EBA’s proposal would trigger a sell-off.
Yet according to Rohde, who also heads Denmark’s Systemic Risk Board, banks will find alternative liquidity sources. Even mortgage lenders would survive the EBA’s plan if it’s approved by the European Commission, he said.
“We believe the issue is manageable and that the market will come up with a solution,” Rohde said yesterday in an interview in Copenhagen. “What will happen is that it’ll be slightly more expensive for financial institutions to uphold liquidity regulation.”
“It’s very difficult to assess the general impact of the EBA proposal as you will have to consider how it’ll move the general equilibrium,” he said. “However, it is our assessment that it won’t be anything that will cripple the Danish bond market, as such.”
The EBA is due to publish its official recommendation this month, with draft technical standards set to be finalized by March. The EU Commission is scheduled to decide in June.
The EBA, which met with its banking stakeholder group yesterday, is ignoring the findings of its own staff in recommending covered bonds be treated as a less liquid asset class than government debt, according to the Danish government.
An October review by the EBA found covered bonds to be as liquid as sovereign debt, with the highest rated securities scoring higher. Rohde said the EBA’s decision to ignore its own report’s findings was “political.”
Members of the EBA’s banking stakeholder group have also criticized the London-based authority’s decision to ignore its own technical report.
Rohde, who before becoming central bank governor in February ran Denmark’s biggest pension fund, ATP, said the EBA’s decision makes no sense.
“It will be a paradox if highly liquid, safe Danish bonds will be treated worse than poorly rated, illiquid government bonds,” he said.
The EBA’s plan was revealed by the Danish government the same day lawmakers in Copenhagen unveiled draft legislation designed to extend maturities on mortgage bonds if refinancing auctions fail. PFA A/S, Denmark’s biggest commercial pension fund, said it’s steering clear of the nation’s mortgage bonds until the “political uncertainty” around them is removed.
Nordea Bank AB, Scandinavia’s largest lender, warned last week that the regulatory onslaught hitting Denmark’s mortgage system may prompt international investors to drop the securities, triggering a capital outflow and putting pressure on the krone’s peg to the euro.
Rohde, who predicts the EU commission will ultimately reject the EBA’s proposal, said he doesn’t expect the krone to be affected by the regulatory changes. Forcing lenders to rely less on krone-denominated securities to meet their liquidity needs may even be positive, he said.
“I don’t think this issue constitutes a currency risk and I don’t want to speculate,” he said. “In general, it is always a good idea to have some diversification in the liquidity buffer. We’ve seen how unfortunate it is if a country’s banks only buy that nation’s government bonds and the country subsequently comes under pressure, so diversification is also a good thing here.”
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