The Banking Institutions' Financial Results

This chapter describes the development in selected key items from the financial statements 2007 of 52 Danish banking institutions. The population accounts for a market share of 87 per cent of total lending by banking institutions in Denmark.

Declining profits, but still at a sound level
The Danish banking institutions posted lower profits in 2007 than in the record year 2006, cf. Table 3. The pre-tax profit declined by approximately 6 per cent for the largest Danish banking institutions in group 1, and by approximately 20 per cent for the institutions in group 2. For the small banking institutions in group 3, the profit fell by 10 per cent. The decrease in earnings can be partially attributed to the extraordinary gain in 2006 from the sale of shares in Totalkredit. Net interest and fee income rose for all three groups as a result of generally higher business volumes. Value adjustments of securities were lower in 2007 than in 2006. The decline is primarily attributed to last autumn's financial turmoil, which has affected credit bonds and equities. Write-downs on loans increased in 2007, although overall, on a net basis, write-downs still made a positive contribution to income. Preliminary data for the 1st quarter of 2008 shows that the falling trend in earnings has continued into 2008.

An increase in costs was also observed, following recent years' strong growth in business volumes. 2007 saw a total increase by 14 per cent in operating costs. Many banking institutions now record higher cost ratios due to staff increases and establishment of new branches. At the same time, the institutions generally applied more resources to the implementation of new regulations in 2007, e.g. MiFID and Basel II. The development in the banking institutions' costs will require efficient cost control in periods of lower economic activity.

In 2007, return on equity before tax was just over 18 per cent for banking institutions in group 1, just over 17 per cent for group 2 and almost 15 per cent for group 3, cf. Chart 35. For all three groups, a lower profit ratio and lower income in relation to business volumes, measured as risk-weighted items, imply a lower return on equity compared with 2006.

High, but declining, lending growth
Lending growth continued to be strong in 2007 for groups 2 and 3, cf. Chart 36, although a clear downward trend is observed from the very high growth rates in the preceding years. The large Danish banking institutions posted lending growth of approximately 11 per cent, while banking institutions in groups 2 and 3 recorded lending growth of approximately 25 per cent. Preliminary data for the banks' lending indicate a further slowdown in lending growth in the 1st quarter of 2008.

Deposit deficits
The banking institutions' deposit deficits rose further in 2007, by kr. 101 billion to kr. 471 billion in total, cf. Chart 37. The growth rate is declining, however. A major factor contributing to the increase in group 1 is Danske Bank's conversion of subsidiaries in Norway and Ireland to branches. The deposit deficit accounts for 23 per cent of lending in group 1, 28 per cent in group 2 and 17 per cent in group 3. At end-2007 no institutions in group 1, 1 in group 2 and 8 in group 3 posted deposit surpluses.

Stable capital structure in groups 2 and 3
The solvency ratio of Danish banking institutions is still considerably higher than the statutory requirement of 8 per cent. However, the high lending growth in recent years places demands on the institutions' capital, and all three groups recorded an increase by just over 20 per cent in risk-weighted items in 2007. The banking institutions in group 3 succeeded in increasing their solvency ratio compared with 2006, whereas it remained virtually unchanged for group 2 and decreased for group 1, cf. Chart 38. One factor contributing to the decrease for group 1 is Danske Bank's extraordinarily high excess capital adequacy at end-2006, since the bank had issued capital for the acquisition of Sampo Bank in 2007.

Some banking institutions introduced the new capital-adequacy rules, i.e. Basel II, in 2007, while others opted for the transitional scheme that allowed the banking institutions to postpone implementation of the new methods and principles for calculation of the capital requirement until 1 January 2008. For most of the institutions by far, the new capital-adequacy rules will initially reduce risk-weighted items and thus improve the solvency ratio. Depending on the banking institutions' risk profile, this effect may, however, be offset by a supplementary capital requirement.

The capital that exceeds the statutory minimum of 8 per cent or more, depending on the institution's individually calculated capital need, must be large enough to cover the losses that are not otherwise covered by earnings. The excess capital adequacy in relation to loans and guarantees tends to be higher for banking institutions in group 3 than for the other two groups. A few institutions in group 3 have an unfortunate combination of very high lending growth and low excess capital adequacy. The total excess capital adequacy for group 1 accounted for 2.8 per cent of loans and guarantees in 2007, while the corresponding figures for groups 2 and 3 were 3.6 per cent and 6.1 per cent, respectively.

Liquidity reserve reduced in recent years
The banking institutions' liquidity reserve can be measured e.g. using the Danish Financial Supervisory Authority's key ratio for liquidity, which shows excess liquidity in relation to the statutory minimum, cf. section 152 of the Danish Financial Business Act. The liquidity reserve, cf. Chart 39, has been considerably reduced in step with the strong lending growth in recent years, particularly for banking institutions in group 3. Out of 36 banking institutions in group 3, 28 had liquidity reserves of less than 100 per cent in 2007, compared with only seven institutions in 2003. Groups 1 and 2 have seen a more stable development, and the liquidity situation has improved a little for group 2.

The banking institutions' average liquidity reserves have decreased from 151 per cent in 2003 to 83 per cent in 2007. The development in the banking institutions' liquidity buffers is important as tight liquidity can limit the institutions' scope for manoeuvre. Ultimately a banking institution may thus be unable to meet its payment obligations in a timely manner.

Reduced interest-rate risk in groups 2 and 3
The banking institutions' interest-rate risk is measured by the Danish Financial Supervisory Authority's key ratio for the share of the core capital, less deductions, that is lost on an increase in the interest rate by 1 percentage point. In accordance with the trend in recent years, the interest-rate risk of small and medium-sized banking institutions has declined to 2.4 and 1.8 per cent, respectively, in 2007, cf. Chart 40. The largest banks' interest-rate risk rose from 0.6 per cent in 2006 to 2.0 per cent in 2007. In group 1, the total interest-rate risk corresponded to 4.9 per cent of total income in 2007, while the figure was 4.4 per cent for group 2 and 6.9 per cent for group 3.

The banking institutions' resilience remained unchanged in 2007
The banking institutions' resilience to mounting losses on loans can be tested in a static analysis based on earnings in 2007 and the capital structure at year-end. Increasing losses on loans tend to initially reduce the profit for the year and then the institution's capital. Chart 41 shows the number of banking institutions that would have had a lower solvency ratio than the statutory 8 per cent given a gradual increase in the loss ratio on loan and guarantees. The resilience is almost unchanged in 2007. Out of the 10 most exposed banking institutions (the first institutions to lose their excess capital adequacy) 3 are in group 1, 5 in group 2 and 2 in group 3.