Denmark’s financial regulator says it won’t abide by a key principle in Europe’s Bank Recovery and Resolution Directive as the nation carves out its own vision for how to tackle insolvencies.
While the BRRD was formulated with a view to letting smaller banks fail if they get into trouble, Denmark says it won’t allow that to happen.
Bankruptcy is “messy,” said Birgitte Holm, deputy director general at the Financial Supervisory Authority in Copenhagen. “If you have a loan in a bank, for instance, and it suddenly goes bankrupt, it can take many, many years before it’s resolved, and we don’t think that’s a good idea.”
Denmark’s aversion to bankruptcies stems in part from its history with bail-ins. It was the first country in Europe to adopt a resolution framework in 2010. A year later, Amagerbanken A/S became Europe’s first lender to test that law, with senior bondholders suffering losses.
The move earned the Nordic country international renown. But the cost was high: ratings companies downgraded banks, leaving them pariahs cut off from capital markets. Danish lawmakers moved to stem the damage, offering banks incentives to take over failing rivals. Ultimately only two local banks were subjected to the bail-in law as the authorities balked at the prospect of traumatizing the industry further.
But the deeper cause of Denmark’s distaste for bank failures even pre-dates its bail-in debacle. Roskilde Bank A/S -- a regional lender that had existed since 1884 -- became a factory for accounting innovation in the years leading up the financial crisis. It was subsequently found to have grossly exaggerated the value of its assets, while management grew richer by awarding itself millions in stock options and bonuses. (Court cases continue.)
After government-backed attempts to find a buyer failed, Roskilde Bank was declared insolvent in August 2008. In the years that followed, about one-third of Denmark’s banks either collapsed or were absorbed by bigger rivals.
“When Roskilde failed, it was the first,” Holm said. “We realized that we had no resolution framework -- nobody did -- apart from an ordinary bankruptcy.”
The shock to Denmark’s financial system from failures by non-systemic banks has persuaded the regulator that it can’t enforce BRRD as it was intended. The directive distinguishes between banks that are systemically important and those that aren’t. The latter are supposed to end up in bankruptcy court if they get into trouble. Creditors shouldn’t lose more if resolution is chosen.
National regulators across Europe are expected to set capital and debt requirements accordingly. Bankruptcy probably would be the cheapest option for a bank, in terms of the minimum own funds and eligible liabilities, or MREL, that it will be required to hold.
Denmark’s FSA is currently considering how much lenders should hold and the proportion of debt to equity. Also under discussion is how much should be subordinated, with final decisions expected by the end of year at the latest.
Nykredit, Denmark’s biggest mortgage lender, recently offered a new type of debt, senior resolution notes, to meet the anticipated requirement. Banks in other countries are likely to follow suit, according to S&P Global Ratings. Just how MREL will ultimately be implemented is hard to say, according to Holm.
“This is still at an early stage in every country in the EU,” and countries have “different systems and even different bankruptcy rules,” she said. “The important thing for Denmark is that we think that an ordinary bankruptcy regime, made for non-financial institutions and not designed for banks, is not really fit for purpose.”