Denmark Reviews Bail-In Law as ‘Terrorists’ Shape Banking

As the euro area tries out its first bank bail-in in Cyprus, the European Union nation that led the way in burden sharing two years ago is now reviewing its commitment to the legislation.

Denmark, whose banks hold assets about four times the size of the $300 billion economy, may reclaim the option to bail out its biggest banks after a government-appointed committee recommended the adjustment to existing laws.

“To have a principle that we would never, under any circumstances, save a bank -- that’s like saying you would never trade with terrorists,” Michael Moeller, chairman of Denmark’s committee on systemically important financial institutions, said in an interview. “But what if they had an atomic bomb that could blow up half the United States?”

Denmark is reconsidering its stance on bail-ins after losing 23 percent of its banks to a real estate bubble that burst in 2008. Banks’ average return on equity has fallen by 73 percent in the period, plunging the economy into a recession. The 2011 failure of Amagerbanken A/S -- the first in the EU to trigger senior creditor losses within a state resolution framework -- tainted Denmark’s entire financial industry as even Danske Bank A/S’s funding costs jumped.

The Sifi committee unveiled its recommendations this month, naming Denmark’s six biggest banks as too big to fail. The designation means the lenders will need to set aside as much as 5 percentage points in additional capital. The committee also proposed giving the regulator broader powers and requiring banks to pay into a fund to finance potential bailouts.

‘Another Set-up’

Danske Bank A/S, the Danish unit of Nordea Bank AB, Jyske Bank A/S and Sydbank A/S, and mortgage lenders Nykredit A/S and BRFkredit A/S should all be named Sifis, the committee said. It also suggested considering DLR Kredit A/S as too-big-to-fail because of its dominant role in mortgage lending to farmers.

Returns on Danske Bank debt has fallen since the committee released its report March 14.

The yield on the bank’s 3.875 percent 1 billion-euro note maturing in Feb. 2017 was little changed at 1.55 percent as of 4:34 p.m. in Copenhagen. The spread to the benchmark euro government curve narrowed two basis points to 138 basis points.

More Tools

“We need another set-up where we have even more tools than we have now,” said Moeller, who also serves on the board of the central bank. “We want to keep options open because when you have something that is very seldom, it’s not very good to have a fixed plan that you have to use for everything.”

The Business Ministry will accept public feedback on the proposals until April 19, after which the matter will be sent to Parliament. The opposition Conservative Party has already signaled it will try to block the higher capital requirements while the Danish Bankers Association said the measures would force banks to cut lending and imperil an economic recovery.

Gross domestic product will expand by 0.8 percent this year, less than the 1.3 percent forecast in December, the Danish central bank said March 20. A burst housing bubble has sent property values plunging more than 20 percent since their 2007 peak, depressing consumption. The housing slump continued into the fourth quarter, with prices dropping 0.5 percent from the previous three months, the statistics agency said today.

“The housing market continues to be in a fragile state,” Steen Bocian, chief economist for Danske Bank, said in a note. “So long as the economic uncertainty continues, there’s no good reason to expect strong price growth or increase in turnover.”

Attracting Deposits

Business Minister Annette Vilhelmsen said the Social Democrat-led government “generally” supports the proposals, which also enjoy the backing of central bank Governor Lars Rohde. Holding more capital “will allow banks to fund themselves more cheaply and to attract more deposits,” Rohde said at a March 20 press conference.

Europe agreed to bail out Cyprus after the nation caved in to demands that it shut down its second-largest bank and force losses on uninsured depositors and bondholders, including senior creditors.

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.

2010 Pledge

Lawmakers in Denmark pledged in 2010 not to bail out banks after taking unprecedented steps to support the industry in the wake of the global financial crisis two years earlier. Less than a year after passing the bail-in bill, two regional lenders failed, shutting most of the nation’s banks out of international funding markets as investors balked at the prospect of losses.

The government responded by passing two more bank packages to encourage consolidation and ease pressure on bank loan books.

The Sifi committee’s recommendations would give the government the option to save a lender without creating incentives for banks to take excessive risk, Moeller said.

Tighter oversight, earlier intervention by the Financial Supervisory Authority and higher capital requirements would minimize the risk of moral hazard, Moeller said. So would a requirement that senior unsecured creditors accept the risk of losses or conversion of their bonds into equity, he said.

“The idea is that, if the worst happens, nobody is certain not to lose money,” Moeller said. “Shareholders, owners of hybrid capital, large depositors -- all can lose money if the situation is bad enough.”

Winning Praise

Denmark’s Sifi proposals have won praise from Standard & Poor’s and Fitch Ratings. The International Monetary Fund said the clarification on how much support Sifis can expect marks a “major step forward” for Denmark.

“The government still has a reason to intervene in a crisis should it be so required,” S&P analyst Per Tornqvist said by phone. “What this is trying to do is to create a price tag for that, a price tag that is higher than in the past.”

Denmark said in January it made a profit of 11.2 billion kroner on its efforts to contain the nation’s banking crisis. About 12 regional banks have been taken over by the state resolution agency since 2008, while another dozen have been absorbed by stronger rivals. The failures have been limited to Denmark’s network of local and community banks.

The Financial Stability Co., Denmark’s resolution agency, reported on March 22 a 611 million krone-profit for 2012 after writedowns shrank to 201 million kroner from 4.2 billion a year earlier. The agency, which isn’t supposed to make a profit on unwinding banks, said it expects net income of zero this year.

“More than any other country in Europe, Denmark has taken the position that large depositors and large bondholders should know they can lose money if a bank comes into problems,” Moeller said.

Still, he said, “If you said that you would never save a bank, nobody would believe you.”