Hybrid Debt Experiment Unleashed as Danish FSA Helps Banks
Denmark’s financial watchdog said banks facing stricter individual capital requirements will be allowed to use new hybrid debt instruments to build their regulatory buffers.
Lenders in the Scandinavian nation hit hardest by the global financial crisis will be free to use bonds that convert to equity at given triggers as well as debt that can absorb losses before a default, Ulrik Noedgaard, director general of the Financial Supervisory Authority, said in an interview.
The FSA’s decision puts an end to speculation among Danish banks they would have to fulfill lender-specific requirements using only equity. Systemically important financial institutions learned in March they may need to hold as much as 5 percentage points extra capital, a proposal lawmakers are still debating. Banks have argued pressure to build reserves is threatening to restrict lending as capital costs rise.
“We think we’re coming with a solution that will address their concerns,” Noedgaard said. “Although the point of reference for us is that these buffers would have to be filled with common equity Tier 1, we are also happy with having some kind of capital in place that has the same properties.”
The FSA plans to shed more light on which hybrid instruments banks can use in coming weeks. The emphasis will be on capital that demonstrates an adequate loss-absorbing potential while the bank is still solvent, Noedgaard said. Banks will only be allowed to use the hybrids to fulfill individual solvency buffers above a minimum 8 percent equity requirement, he said.
The FSA is still looking into the use of hybrids to fulfill proposed crisis-management buffers for too-big-to-fail banks, Noedgaard said. The Sifi committee recommended the use of hybrids in March proposals that have yet to be approved by lawmakers.
While opening a door to less costly funding, relying on hybrid debt also hides potential risks as rating companies redefine their assessments of the securities.
The prospect of a change of rules at Standard & Poor’s is hampering Danske Bank A/S (DANSKE)’s ability to plan its capital structure. S&P said in March it’s reviewing its criteria for risk-adjusted capital in a move that threatens to reduce the loss-absorbing potential of a $1 billion 2037 bond that Denmark’s biggest bank issued in September.
S&P asked banks on March 27 for feedback on a proposal to revise its hybrid capital criteria. The rating company said it was considering the changes “to further emphasize regulatory classification in our assessment of whether an instrument is able to absorb losses while the bank is a going concern.”
Noedgaard said Denmark’s FSA is aiming to create standards that ensure hybrid securities offered by the nation’s banks follow rules enforced elsewhere.
“We are aiming at coming up with demands that are consistent with what you see in other countries, so it should also be possible to issue for Danish banks,” Noedgaard said. Though not limited to Sifis, the instruments will render their capital requirements “less stringent than if you had to fulfill everything with common equity Tier 1,” he said.
Given the freedom banks will have to compose their regulatory buffers, the FSA has little patience for claims that stricter capital requirements will hurt lending, Noedgaard said.
“You can discuss the merits or not of Sifi charges, but you cannot say the current lending level in Danish banks is constrained by the current and expected future capital requirements,” Noedgaard said. “That is just not correct.” He says the main issue is a lack of demand for credit.
Danish banks have pushed back against the Sifi proposals. Danske Bank and Nykredit A/S, the country’s largest mortgage lender, are now lobbying lawmakers to reject the requirements, arguing stricter rules should be matched by an explicit pledge that they’ll be exempt from Denmark’s bail-in laws.
The FSA, which oversaw the European Union’s first senior bank creditor losses within a resolution framework in 2011, eased its stance on bank closures this year. Instead of only allowing banks 48 hours to find capital, the regulator is now giving insolvent lenders the time they need to get back on their feet, it said in May.
The latest bank to benefit from the softer approach was Oestjydsk Bank A/S, which announced Friday it is selling shares to recapitalize.
Bank lending to businesses fell an annual 13 percent in April to 387 billion kroner, the second lowest level in at least seven years, the central bank said May 28. Bank lending to households dropped 5 percent.
“Reducing these Sifi charges for example -- or any other capital requirement for that matter -- will not provide much growth in the Danish economy,” Noedgaard said. “But it will certainly make the financial system less stable going forward.”
To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at firstname.lastname@example.org