Too-Big-to-Fail Banks Need Bailout Pledge, Danish Council Says

Banks identified as systemically important need an explicit guarantee of state backing to match their extra capital requirements, according to Denmark’s Economic Council.

March 14 proposals by a government-backed committee on how to treat Denmark’s too-big-to-fail lenders should make clear that the state would be willing to bail them out, said Claus Thustrup Kreiner, co-chair of the government-backed council in Copenhagen. Vagueness in the existing text will only deter bond investors and raise bank funding costs, he said.

“The moral hazard issue is created as soon as any level of government support is introduced,” Kreiner said in an interview. “We prefer to have clarity and transparency over uncertainty and to make the public backing explicit.”

The Economic Council is adding its voice to a debate that has pitted Denmark’s biggest banks against its policy makers. The six lenders identified by a public committee as too big to fail say they need to be shielded from Danish bail-in laws for their designation to be meaningful. The government and central bank counter that such a step would encourage banks to take greater risks and place too big a burden on the state.

“The challenge is to match government guarantees to capital requirements,” Kreiner said. That will help “avoid making state backing a competitive advantage,” he said.

Housing Bubble

The Association of Danish Mortgage Banks is holding a town hall today in an effort to persuade lawmakers to soften the Sifi proposals. The event will seek to show how the recommendations risk raising capital costs and withholding credit from an economy struggling to recover from a burst housing bubble and a spate of regional bank failures, according to the association’s deputy director, Peter Jayaswal.

The March proposals, which have yet to be passed by lawmakers, seek to raise capital requirements for systemically important financial institutions by as much as 5 percentage points. Committee Chairman Michael Moeller said this month the door should be opened to the option of bailouts, though “the state shouldn’t give a guarantee, binding for all future, completely independent of the situation.”

Danske Bank A/S Chief Financial Officer Henrik Ramlau-Hansen said May 2 Denmark should follow neighboring Sweden, where the four largest banks are guaranteed state support in exchange for some of Europe’s toughest capital requirements.

Same Rules

Moody’s Investors Service said last month Denmark’s Sifi proposals won’t provide bondholders more safety and said the framework was unlikely to trigger ratings upgrades. Banks in Sweden enjoy three points on Moody’s government support scale, compared with only one in Denmark.

The rating company ranks Danske Baa1, four grades below the Aa3 rating it gives Nordea Bank AB of Sweden. Danske says the lower credit grade adds to funding costs at a time when they’re being asked to raise additional capital.

Danske, Denmark’s biggest bank, estimates it will need to hold 17.6 percent of risk-weighted assets in capital by 2022 to meet the Sifi requirements, according to its first-quarter presentation. The bank’s regulatory capital was 21.6 percent as of March 31, including 3 percent state hybrid debt.

Investors pay about 43 basis points more to insure against a default on senior unsecured debt sold by Danske Bank versus similar contracts on Nordea, according to five-year credit-default swap data compiled by Bloomberg.

Senior Creditors

Danish banks have struggled to persuade investors they’re as safe as their Swedish rivals after Denmark became the first European Union country to force losses on senior bank creditors within a resolution framework. The 2011 failure of Amagerbanken A/S left most banks in Denmark locked out of funding markets as creditors shunned the nation’s bail-in legislation.

Benny Engelbrecht, who sits on Denmark’s parliamentary committee on bank laws for the ruling Social Democrats, said he’s unlikely to back proposals that move away from Denmark’s practice of bailing in unsecured bank creditors. That stance also applies to systemically important banks, he said.

“We won’t back giving Danish Sifis explicit government support,” he said in an interview earlier this month. Denmark’s financial industry assets are almost four times the size of the $300 billion economy.

Per Callesen, deputy governor of Denmark’s central bank, said in an interview last week financial industry demands they be exempt from bail-in laws are out of step with reality.

“A wish for more explicit government guarantees would be rather uniquely Danish,” Callesen said May 24. “I haven’t heard indications from elsewhere that this would be the preferred route to go down.”

Before it's here, it's on the Bloomberg Terminal.