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"Report and Accounts 2001"

Report on Danmarks Nationalbank's accounts

Danmarks Nationalbank's financial risks mainly comprise market risks. The market risk is related primarily to the interest-rate and foreign-exchange sensitivity. The foreign-exchange sensitivity primarily concerns assets denominated in euro. The credit risk is very small, since Danmarks Nationalbank exclusively holds claims on counterparties with a high credit standing, and to a significant extent requires the pledging of collateral. During 2001 Danmarks Nationalbank's market risk, measured by Value-at-Risk (VaR), increased from kr. 3.2 billion to kr. 5.9 billion. The increase is primarily related to the greater volatility of the financial markets in the 2nd half of 2001, although the augmentation of the foreign exchange reserve also had an effect.

Danmarks Nationalbank's accounts for 2001 show a profit of kr. 4.8 billion, compared to kr. 5.7 billion in 2000. This adjustment is due mainly to the decrease in value adjustments by kr. 1.2 billion to kr. 0.1 billion. Of the profit for the year, kr. 3.3 billion is payable to the central government. Danmarks Nationalbank's net capital has increased by kr. 1.5 billion to 46.7 billion.

Danmarks Nationalbank's management of financial risks

Danmarks Nationalbank holds financial assets and liabilities. This entails that Danmarks Nationalbank is exposed to a number of financial risks that can affect the financial result. The principal assets are foreign deposits and securities, domestic bonds and loans to Danish banks. The principal liabilities are banknotes and coins in circulation, deposits and certificates of deposits, and the deposits of the central government, cf. the balance sheet on pp.112-114. Danmarks Nationalbank is primarily exposed to market risks and to a lesser degree to other types of risk, e.g. credit risks.

Market risk
The market risk is the risk of Danmarks Nationalbank suffering a loss as a consequence of price fluctuations on the financial markets. Losses may arise primarily as a consequence of fluctuations in interest and exchange rates.

Generally, a distinction is drawn between sensitivity and risk. Sensitivity is the extent to which Danmarks Nationalbank will incur losses on a given change in a specific risk factor, such as the interest rate. The compilation of the foreign-exchange sensitivity is based on market values of foreign exchange outstandings. interest-rate sensitivity is compiled on the basis of the krone duration which states the capital loss to Danmarks Nationalbank as a consequence of an increase in interest rates by 1 percentage point.

On compiling the risk, the probability of loss is evaluated by combining sensitivity with the probability of a change in the risk factor concerned. For example, Value-at-Risk (VaR) is used to compile the total market risk. It indicates the maximum loss that can be expected within a given time frame with a given probability.

Interest-rate risk
The interest-rate risk indicates the capital loss which Danmarks Nationalbank will suffer as a consequence of a change in interest rates. For Danmarks Nationalbank, which holds significantly more fixed-rate assets than liabilities, an increase in interest rates will impose a loss. Experience shows that in the long term fixedrate bonds yield higher returns than placements at shorter maturities. Over an extended period, Danmarks Nationalbank will therefore increase its return by assuming a certain interest-rate risk.

At the end of 2001 the interest-rate sensitivity of the foreign portfolio accounted for approximately 60 per cent of the total interest-rate sensitivity. In order to spread the interest-rate risk on the foreign portfolio the sensitivity is diversified into several markets, cf. Table 9.

Table 9 Interest-rate sensitivity of Danmarks Nationalbank

The sensitivity to changes in Danish interest rates can be related to Danmarks Nationalbank's portfolio of securities, comprising government, mortgage-credit and Danish Ship Finance bonds. Since mortgage-credit bonds are usually callable, and can thus be redeemed prematurely, the compilation of the interest-rate sensitivity of these bonds cannot be determined by the same method as for e.g. uncallable government bonds. A model is therefore used which takes the call option into account on compiling the interest-rate sensitivity of mortgage-credit bonds.

Foreign-exchange risk
foreign-exchange risk is the risk of capital losses as a consequence of fluctuations in exchange rates. Danmarks Nationalbank holds considerable foreign-exchange assets, first and foremost the foreign-exchange reserve which serves as an intervention reserve. Like other central banks, Danmarks Nationalbank therefore cannot avoid exposure to a foreign-exchange risk.

The exchange-rate risk on the foreign-exchange-denominated assets is limited by forward sale of dollars, sterling and yen against euro. This reduces the exchange-rate risk on Danmarks Nationalbank's bond and money-market placements in those currencies. For example, at the close of 2001 Danmarks Nationalbank held sterling assets for kr. 11 billion,but had sold sterling forward for kr. 11 billion. The total net sterling outstandings thereby amounted to zero in net terms. The exchange-rate risk cannot be eliminated completely by forward sale of currency against kroner, since this will affect the krone rate.

Danmarks Nationalbank's foreign-exchange sensitivity almost entirely concerns the euro, cf. Table 10. A change in the krone's rate against the dollar, yen and pound sterling has only a modest effect on Danmarks Nationalbank's result.

Table 10 Foreign-exchange exposure of Danmarks Nationalbank

Note:    Negative amounts indicate that Danmarks Nationalbank holds liability when the foreign currency increases in value. The value of SDR is distributed on the respective currencies.

Danmarks Nationalbank's foreign-exchange outstandings increased by kr. 27 billion to kr. 161 billion at end2001. The increase is related to the foreign-exchange reserve. Danmarks Nationalbank's gold stock entails exposure to the gold price. The gold stock is held at a constant level.

In 1992 coordinated management of Danmarks Nationalbank's foreign-exchange risk with the foreign-exchange risk on the central government's foreign debt began. The net position, i.e. the difference between Danmarks Nationalbank's foreign-exchange-denominated assets and the central government's foreign-exchange-denominated liabilities, has in recent years been primarily in euro. In view of Denmark's fixed exchange-rate policy the euro is found to be the currency entailing the lowest risk. As the exchange-rate risk on the central government's liabilities and Danmarks Nationalbank's assets is primarily in euro, the coordinated management was discontinued as of 1 January 2001.

Value at Risk
Danmarks Nationalbank uses various risk measures to evaluate the market risk. One of these is Value-at-Risk (VaR), which besides the probability of interest-rate and exchange-rate losses based on historical fluctuations also includes the covariation between them. VaR is supplemented with stress scenarios to calculate the impact of extreme fluctuations in interest and exchange rates on Danmarks Nationalbank's portfolio.

Table 11 Danmarks Nationalbank's value-at-risk

At end2001 Danmarks Nationalbank's VaR was kr. 5.9 billion^[43], cf. Table 11. During the next year, with a probability of 95 per cent Danmarks Nationalbank will thus have a maximum total capital loss of kr. 5.9 billion. In the long term Danmarks Nationalbank is only expected to have a loss exceeding kr. 5.9 billion in one out of 20 years. VaR at the close of 2000 was kr. 3.2 billion. The increase in VaR is related to the greater volatility of the financial markets in the 2nd half of 2001 compared to the same period of 2000. Moreover, Danmarks Nationalbank's portfolio has increased significantly.

The exchange-rate risk on the euro is not a traditional market risk, since Danmarks Nationalbank not only may, but is also obliged, to influence the krone/euro rate. Moreover, Danmarks Nationalbank will only sustain a loss if the krone strengthens against the euro. It can therefore be of interest to evaluate VaR without the exchange-rate risk related to the euro. VaR excluding the exchange-rate risk on the euro is kr. 4.3 billion. Elimination of the exchange-rate risk related to the euro thus entails a decrease in VaR by 27 per cent.

Danmarks Nationalbank's net capital totalled kr. 47 billion at the close of 2001, cf. the balance sheet on p. 121. VaR as a ratio of net capital has increased from 7 per cent in 2000 to 13 per cent in 2001.

Table 12 Danmarks Nationalbank's loss in a stress scenario, end-2001

Note:    Danmarks Nationalbank's gold stock is included in foreign-exchange losses.

Stress scenario
The VaR calculations provide information on the general risk of loss, but not on the extent of the losses in the event of extreme market fluctuations. Stress scenarios are used for this purpose. The scenarios set out extreme, but realistic, scenarios of market development, and determine how Danmarks Nationalbank's current portfolio is affected by these market fluctuations. It is difficult to set out realistic extreme market fluctuations. Therefore data is selected from sub-periods between 1991 and 2001 in which the development in interest and exchange rates was particularly unfavourable to Danmarks Nationalbank. This data is used to set up three scenarios:

• Scenario 1: The one-year period that has given the greatest total interest and exchange-rate losses to Danmarks Nationalbank.
   
• Scenario 2: The one-year period that has given the greatest total interest-rate loss, combined with the term of years that has given the greatest total exchange-rate loss for Danmarks Nationalbank. The terms do not have to be concurrent.
   
• Scenario 3: The one-year period that for each individual one-year interest-rate segment in each currency has given the greatest interest-rate loss, combined with the one-year period that for each currency has given the greatest exchange-rate loss for Danmarks Nationalbank. The terms do not have to be concurrent.

In view of the current portfolio structure the three scenarios give a total capital loss of between approximately kr. 11 and 16 billion, cf. Table 12.

The most pessimistic scenario (scenario 3) will give Danmarks Nationalbank a capital loss of 35 per cent of net capital.

Liquidity risk
The principal purpose of the foreign-exchange reserve is for Danmarks Nationalbank to be able to intervene in the foreign-exchange market. In the management of the foreign-exchange reserve it is therefore very important to ensure that the greater part of the reserve can quickly be converted to liquid funds. Therefore a large proportion of the foreign-exchange reserve is placed in the money market or in bonds with a high degree of security, so that they can easily be realised or used as collateral in various liquid markets.

Danmarks Nationalbank also has access to foreign exchange via thecentral government's Commercial Paper programme amounting to 12 billion dollars. Moreover, there is an opportunity to borrow at the ECB in accordance with the ERM II agreement.

The placement of the portfolio of domestic securities does not give the same weight to liquidity considerations.

Credit risk
The credit risk is the risk of loss due to a counterparty's default on obligations.

To reduce the credit risk Danmarks Nationalbank seeks to spread its assets among counterparties with a high credit standing. Moreover, to a large extent collateral is required. The credit risk is therefore very small.

The credit risk on the foreign claims, i.e. claims on foreign governments, banks, etc., is managed on the basis of the ratings given by international rating agencies. Moreover, all significant outstandings are subject to maximum limits.

For deposits with foreign banks repo agreements with government bonds as collateral are used to a great extent. Should a repo counterparty be subject to compulsory liquidation Danmarks Nationalbank's deposit is covered by the collateral provided.

Danmarks Nationalbank's holdings of foreign bonds are issued or guaranteed^[44] by states with a high credit rating, or issued by supranational institutions. Danmarks Nationalbank thus does not hold corporate bonds or bonds issued by governments with a low credit rating.

On placement of the domestic securities portfolio great weight is attached to the high credit standing of the issuer. The securities portfolio thus almost exclusively comprises government bonds, mortgage-credit bonds and Danish Ship Finance bonds.

Loans related to the monetary-policy operations, the banks' intra-day credits and cash depots are granted solely against bonds as collateral, and are not included in Table 13.

Table 13 Total credit exposure on the foreign-exchange reserve and the domestic securities portfolio etc., end-2001

Note:    Moody's credit rating is used. The scale ranges from Aaa to D, where Aaa is the highest credit rating. For further details of rating, see Kristian Sparre Andersen and Anders Matzen, The Use of Ratings in the European Capital Markets, cf. Danmarks Nationalbank, Monetary Review, 3rd Quarter 1998.
¹    Individual Danish mortgage-credit institutes and similar.
²    Exclusively covers BIS and IMF.

Since more than 90 per cent of the foreign-exchange reserve and the domestic securities portfolio are placed with supranational institutions or in assets with a rating of Aa3 or higher, the credit risk to Danmarks Nationalbank is very small, cf. Table 13.

Presentation of Danmarks Nationalbank's accounts

Danmarks Nationalbank's accounts with notes are shown on pp. 115-127.

The accounts for 2001 have been prepared in accordance with the same accounting policies as the previous year, with the exception that shares and fixed assets are now capitalised, whereas previously they were written down to respectively kr. 1 and kr. 0 in the profit and loss account.

The comparative figures have been adjusted in accordance with the change of accounting policy.

The accounts reflect that Danmarks Nationalbank issues banknotes and coins, administers the foreign-exchange reserve and functions as banker to the banks and mortgage-credit institutes, and to the central government.

The profit from financial items was kr. 5,603 million and thereby kr. 636 million lower than in 2000. The decrease primarily reflects negative value adjustments of kr. 1,186 million from kr. 1,310 million in 2000 to kr. 124 million. After income from shares, etc., of kr. 29 million, other income from ordinary operations of kr. 4 million, expenses of kr. 514 million, depreciation and amortisation of tangible fixed assets of kr. 28 million, and other expenditure on ordinary operations of kr. 300 million, the profit for the year is kr. 4,794 million, or kr. 904 million less than in 2000.

The balance sheet has increased from kr. 237.8 billion to kr. 295.3 billion. The increase in assets is primarily due to foreign assets and loans to banks and mortgage-credit institutes, while the increase in liabilities is primarily related to an increase in certificates of deposit which is, however, partly offset by a decrease in deposits from banks and mortgage-credit institutes.

The profit and loss account

Net income from interest
Net income from interest totalled kr. 5,479 million which is kr. 550 million more than in 2000.

Income from interest on foreign assets rose by kr. 638 million to kr. 6,453 million. The increase is a consequence of higher average interest rates than in 2000, while the foreign-exchange reserve on average was kr. 4.6 billion less in 2001 than in 2000.

Net interest to banks and mortgage-credit institutes (interest on deposits and certificates of deposit less interest on lending) was kr. 1,186 million, compared to kr. 983 million in 2000. The rates of interest for certificates of deposit and lending are identical, while the rate of interest for deposits is lower. The increase in the total net interest expenditure of kr. 203 million is related to the higher interest rates in 2001 than the equivalent rates in 2000, and that the average net position vis-à-vis Danmarks Nationalbank of the banks and mortgage-credit institutes was higher in 2001 than in 2000.

Danmarks Nationalbank's interest expenditure on the central government's deposit rose by kr. 17 million to kr. 2,209 million. The deposit was on average lower than in the preceding year, while the discount rate, which is the rate of interest on the deposit, was higher.

Interest on loans to other borrowers of kr. 180 million is generally unchanged.

Interest to other depositors, etc., fell by kr. 27 million to kr. 267 million, primarily because Danmarks Nationalbank's obligations to Danish Ship Finance were reduced during the year due to redemptions, cf. p. 96 of the Annual Report for 1997.

Interest on domestic bonds at kr. 2,568 million is by and large unchanged.

Value adjustments, etc.
The value adjustments, etc. resulted in a gain of kr. 124 million.

Value adjustment of Danmarks Nationalbank's gold stock gave a gain of kr. 296 million, which is primarily related to an increase in the dollar, while the price of gold in dollars was almost unchanged.

The value adjustment of foreign-exchange positions comprises the value adjustment of the foreign-exchange reserve, as well as the value adjustment of unsettled foreign-exchange contracts, currency and interest-rate swaps, domestic foreign-exchange balances, and the liability: counterpart of Special Drawing Rights (SDR) allocated by the IMF. The downward value adjustment of kr. 299 million can be attributed to a foreign-exchange loss of kr. 677 million and a market-value gain of kr. 378 million. The foreign-exchange loss is related to a loss in euro and dollars and a gain in yen.

The value adjustment of domestic bonds gave a total gain of kr. 127 million.

The marketvalue gain on domestic and foreign bonds can be related to the general decrease in international interest rates, which is set off partly by the fact that a large proportion of the bond portfolio at the beginning of the year had a market value above par, and therefore automatically released a capital loss in step with redemption, or because the redemption date was forthcoming.

Expenses
Total expenses decreased by kr. 3 million to kr. 514 million, or 0.6 per cent.

Staff expenses rose by kr. 8 million to kr. 301 million. This increase reflects an increase in wages, salaries and fees, and other staff expenses, of kr. 9 million, or 3.4 per cent, and a decrease in the provision carried as expenditure for support and severance schemes of kr. 1 million.

Other expenses fell by kr. 11 million to kr. 213 million, equivalent to a decrease of 5.1 per cent.

Other expenditure on ordinary operations
This item concerns a payment to Danmarks Nationalbank's Pension Fund.

Profit for the year
The result for the year is a profit of kr. 4,794 million, against a profit of kr. 5,698 million in 2000. Kr. 25 million is transferred to Danmarks Nationalbank's Anniversary Foundation of 1968. In accordance with the practice for allocation of profits the gain on value adjustments of kr. 124 million is allocated to the Value Adjustment Reserve, which hereafter amounts to kr. 1,454 million. An amount of kr. 1,376 million is allocated to the General Reserves, which together with the contribution to Danmarks Nationalbank's Anniversary Foundation of 1968 corresponds to 30 per cent of the profit excluding value adjustments. The General Reserves hereafter total kr. 44,951 million. The remainder of kr. 3,269 million is payable to the central government.

The balance sheet

Gold
The stock of gold amounted to kr. 5.0 billion at the end of the year, compared to kr. 4.7 billion in 2000. The increase is related to the increase in the price of gold calculated in kroner of 6 per cent during 2001.

Foreign assets
Assets amounted to kr. 138.6 billion at the end of the year, compared to kr. 110.9 billion in 2000, equivalent to an increase of 25 per cent. The assets are placed in euro (65 per cent), dollars (22 per cent), pounds sterling (8 per cent) and yen (5 per cent). The positions are held mainly in highly rated government bonds, government-guaranteed bonds, deposits with central banks and commercial banks, or as lending against collateral in government bonds.

Foreign assets are the most significant items of the foreign-exchange reserve, together with the stock of gold, claims on the IMF and foreign liabilities.

Claims on the International Monetary Fund (IMF)
This balance-sheet item comprises Denmark's IMF quota less the IMF's holdings of Danish kroner at Danmarks Nationalbank, with addition of Danmarks Nationalbank's holdings of Special Drawing Rights (SDR) and loans for the Poverty Reduction and Growth Facility Trust. During the year this asset increased by kr. 3.4 billion to kr. 8.5 billion, which is related to an increase in the drawing by the IMF, as well as a minor increase due to value adjustments.

Loans, etc.
Loans mainly comprise accounts with banks and mortgage-credit institutes and must be evaluated together with the item deposits, etc., and certificates of deposit. The net assets of the banks and mortgage-credit institutes with Danmarks Nationalbank increased from kr. 32.0 billion to kr. 51.8 billion during the year. This item includes loans related to cash depots, which decreased from kr. 2.7 billion to kr. 2.1 billion.

Domestic bonds
The holdings amount to kr. 41.0 billion, which is an increase of kr. 1.2 billion from 2000. The holdings are almost exclusively mortgage-credit bonds (kr. 20.4 billion), government bonds (kr. 15.9 billion) and bonds issued by Danish Ship Finance (kr. 3.5 billion).

Banknotes and coins in circulation
Banknotes in circulation increased by kr. 2.3 billion to kr. 43.0 billion, while coins in circulation increased by kr. 0.2 billion to kr. 4.3 billion. Banknotes in circulation include Faroese notes at kr. 332 million. The increase in banknotes in circulation generally matches the trend in recent years, cf. pp. 62-63.

Foreign liabilities
The liabilities increased by kr. 0.6 billion to kr. 3.7 billion and comprise krone deposits with Danmarks Nationalbank from supranational institutions and other central banks.

Counterpart of Special Drawings Rights allocated by the IMF (SDR)
The allocation was unchanged during the year, and the value adjustment for the year was minor.

Deposits, etc.
Besides deposits from banks and mortgage-credit institutes of kr. 32.5 billion this item includes other deposits of kr. 5.5 billion, of which the accounts of Danish Ship Finance at kr. 1.9 billion and of VB Finans at kr. 1.9 billion are the largest.

Certificates of deposit
Certificates of deposit, which are Danmarks Nationalbank's shortterm debt securities sold to banks and mortgage-credit institutes, increased by kr. 61.7 billion to kr. 113.6 billion.

Central government
The centralgovernment deposit increased from kr. 37.7 billion to kr. 43.5 billion. The central government's share of the profit of Danmarks Nationalbank is included in this amount.

Net capital
The net capital amounts to kr. 46,705 million, which is the net capital at the beginning of the year of kr. 45,205 million with addition of the allocation to the General Reserve of kr. 1,376 million and positive value adjustments of kr. 124 million.

Copenhagen, end February 2002.

Bodil Nyboe Andersen           Torben Nielsen                      Jens Thomsen

At the meeting of the Board of Directors held on 18 March 2002 the Board of Governors reported on the activities of Danmarks Nationalbank. The report was noted.

Danmarks Nationalbank's accounts for 2001 were submitted by the Board of Governors for adoption on the recommendation of the Committee of Directors. The Board of the Directors and the Royal Bank Commissioner accepted the recommendation.

Footnotes

^[43] VaR is calculated on the basis of estimated volatilities and correlations between the relevant risk factors for the last 160 days. VaR is determined by combining these estimates with Danmarks Nationalbank's portfolio composition at the end of 2001.

^[44] The government-guaranteed securities include securities with an implicit government guarantee.

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Version 1.0 March 2002 Nationalbanken.
Published by Danmarks Nationalbank March 2001, http://http://www.nationalbanken.dk/