The Domestic Financial System

In 1997 the minimum coupon rate was maintained at 4 per cent and 4-per-cent bonds for large amounts were issued.

The total profit for the year of the mortgage-credit institutes was kr. 7.6 billion. Provisions on debtors carried back exceeded new losses and provisions.

The Bond Market

The development in interest rates on the Danish bond market is described on p. 33ff.

The outstanding volume of krone-denominated bonds listed on the Copenhagen Stock Exchange rose in 1997 from a nominal amount of kr. 1,712 billion to kr. 1,793 billion, cf. Table 17 of the Appendix of Tables. This is the result of a gross supply of bonds of kr. 452 billion and gross redemptions of kr. 375 billion, cf. Table 15 of the Appendix of Tables. The net supply of new bonds is attributable exclusively to mortgage-credit bonds and other bonds, while the volume of domestic government securities in circulation declined by kr. 3 billion.

The minimum coupon rate was maintained at 4 per cent in 1997 after being lowered extraordinarily on October 22, 1996. The minimum coupon rate for the first half of 1998 has again been fixed at 4 per cent. As from the adjustment of the minimum coupon rate until the end of 1997 issues of 4-per-cent bonds totalled approximately kr. 80 billion, in addition to central-government borrowing. The large gross supply of new bonds is due to the fact that after tax these bonds are attractive to private investors, and that both resident and non-resident borrowers have found it advantageous to use this market. The mortgage-credit institutes constitute the largest group of issuers, accounting for 35 per cent, while non-resident borrowers and entities subject to state guarantees account for respectively 25 per cent and just under 20 per cent. Non-resident borrowers operate extensively in the euro-krone market, but this is the first time that they are significant participants in the domestic Danish capital market.

Issues of 4-per-cent bonds were particularly significant in the first half of 1997, but were less important in the second half-year. This development is probably the result of a "hoarding effect" due to expectations at the beginning of 1997 that the low minimum coupon rate was only temporary. In addition, demand has gradually become more moderate in step with the expansion of the market.

The borrowing terms offered in the 4-per-cent-bond market have been utilized by a number of borrowers in combination with the swap market. In connection with the issue of bonds these issuers, who have preferred financing at floating interest rates, have swapped from fixed to floating interest rates. Activity in the Danish swap market has tended to increase.

Chart 27 shows the ownership distribution of bonds with a nominal interest rate of 4 per cent. The Chart shows that private investors are the principal investor group.

In 1997 there were 59 issues of krone-denominated bonds listed outside Denmark - euro-krone bonds - for a total nominal amount of kr. 25 billion, cf. Table 18 of the Appendix of Tables. This represents an increase of kr. 4 billion in relation to 1996. The greater interest is probably related to the fact that particularly private non-resident investors find such bonds to be of interest in view of the stable krone and the yield differential to Danish government securities.

Throughout 1997 demand for mortgage-credit loans at variable interest rates has continued, against the background of the relatively low short-term interest rates. Such loans are granted on the basis of uncallable bullet bonds at varying maturities. At the turn of the year 1997-98 a relatively large volume of loans required refinancing. One mortgage-credit institute chose to refinance a proportion of the amount by auction, rather than by tap issue as usual. Auctions have never before been used for mortgage-credit bonds.

The proportion of Danish krone-denominated bonds held by non-resident investors increased slightly in 1997, to just over 18 per cent. Government securities continue to be the principal element of non-resident investors' holdings of krone-denominated bonds. Their share of government securities in circulation rose from 37 per cent at end-1996 to 41 per cent at end-1997, whereas the share for mortgage-credit bonds was approximately 5 per cent. A likely explanation for the relatively low share of mortgage-credit bonds is that non-resident investors prefer to invest in simple bond types. Mortgage-credit bonds are typically callable annuity bonds, which are more complex than the uncallable bullet government issues. Finally, the greater liquidity of the government securities market may also be a contributing factor, since only few mortgage-credit-bond series have a circulating volume exceeding kr. 20 billion.

For many non-resident investors an international rating of the bonds is a condition for investment. Most of the Danish mortgage-credit institutes have now obtained a rating of their most frequently traded bonds. Moody's Investor Service has given issues by the mortgage-credit institutes the rating Aa2 or Aa3, i.e. one to two steps below the Kingdom of Denmark's foreign loans (Aa1) and two to three steps below domestic government loans (Aaa). Both Aa2 and Aa3 are good ratings. Bond series without joint and several debtor liability have been given the same rating as bond series with joint and several debtor liability issued by the same mortgage-credit institute. A rating does not necessarily entail a price difference between rated and non-rated mortgage-credit bonds, although usually non-resident investors have preferred rated bonds. In this respect they differ from resident investors who do not attach much importance to the rating. On this basis no price differences have arisen in the bond market between bonds which apart from their rating are identical.

Nordic Stock-Exchange Cooperation

In June 1997 the Copenhagen Stock Exchange and the Stockholm Stock Exchange signed a declaration of intent on far-reaching cooperation to establish a joint Nordic securities market, Nordic Exchanges - NOREX. In the first instance a joint company is established to market the services of the stock exchanges. This company was established at the beginning of 1998. As an element of this cooperation the Copenhagen Stock Exchange will acquire the Swedish trading system SAX 2000 for share trading. In the longer view the cooperation is envisaged to create a joint Nordic securities market where all types of securities are traded using the same technical platform.

In December 1997 the Danish Securities Centre, VP, and the Swedish Securities Centre, VPC, declared their intention to enter into close cooperation. Initially the purpose is to support the cooperation between the Swedish and Danish stock exchanges. However, in the future this co-operation will also give the two securities depositories a stronger position from which to face the intensified competition in Europe in this area too.

The Banks

In 1997 the banks achieved a favourable financial result for the third consecutive year. The profit before tax was kr. 13 billion, which is equivalent to the level in 1996.

Again in 1997 part of the profit was attributable to positive value adjustments of bond and share portfolios. The rise in Danish share prices by 43 per cent (total index) contributed to the result. However, just under 60 per cent of the share portfolio originates from pooled pension funds where depositors' savings accrue interest at the yield on an underlying portfolio of securities owned by the bank. This part of the capital gains thus does not affect the banks' financial result. Adjusted for the yield on pooled pension funds, included in the banks' balance sheets, the value adjustments of securities and foreign exchange in 1997 totalled kr. 2 billion, compared to kr. 4.6 billion in 1996.

Total losses and provisions on debtors fell again in 1997, to kr. 2.3 billion, which is equivalent to 0.3 per cent of loans and guarantees. This is the lowest ratio since 1976 and 1977 when the provisions ratios were 0.2 and 0.3 per cent. In the period from 1975 up to and including 1997 the average provisions ratio was 1.2.

In 1997 net income from interest and fees totalled kr. 36 billion, which is equivalent to the level of the two preceding years. In 1997 income from interest accounted for 76 per cent of total income from interest and fees, compared to 78 per cent in 1996 and 81 per cent in 1995. It thus appears that a gradual shift is taking place from income from interest towards income from fees.

In the same period income from interest may be "inflated" due to high nominal interest rates on the banks' bond portfolios. Bonds at high nominal interest rates are traded above par, but on the other hand entail a negative value adjustment as the price moves towards par in connection with a reduction of remaining maturity.

In 1997 the growth in lending was 17 per cent, against 12 per cent in 1996. The growth rate for lending is stronger than the increase in net income from interest and fees because the interest margin has narrowed.

Staff and administration costs amounted to kr. 20 billion in 1997 and are almost unchanged in relation to the last few years. Since the extensive staff reductions at the beginning of the 1990s the banks have overall not reduced the nominal costs significantly.

Total net extraordinary expenditure fell from around kr. 2 billion in both 1995 and 1996 to kr. 0.5 billion in 1997.

The solvency ratio of the banks taken as one at end-1997 was 11.7 per cent, equivalent to a decrease by 0.4 percentage points from 1996. The risk-weighted assets and market risks have thus risen more than the capital base, despite the consolidation of the year (profit after tax and dividend) and raising of subordinate capital totalling kr. 5 billion net. However, the solvency ratio is still well above the statutory minimum requirement of 8 per cent. At end-1997 the Tier-I ratio was 9.3.

Recent years' development towards a single Nordic banking market continued in 1997, when the first major cross-border Nordic merger took place, i.e. the merger of Swedish Nordbanken with Merita Bank of Finland. The major Danish banks also intensified their Nordic activities during the year via acquisitions or new establishments. At the same time the Swedish banks in particular increased their activities in Denmark. Previously, competition between the Nordic banks was concentrated on corporate customers, e.g. including the raising of international loans, underwriting and mergers and acquisitions, as well as asset management. The structural adjustments in 1997 have created the basis for more intense competition and there are signs that the competition will spread to all traditional banking services, including those offered to retail customers.

The maintenance and upgrading of existing computer systems have developed into a permanent activity for the banks. Prior to the introduction of the single European currency, the euro, computer systems must be adjusted to handle a new currency, even though the requirements are less extensive in Denmark than in the euro countries. Systems must also be restructured to handle the correct date and year when the new millennium begins - the year-2000 problem. More and more computer skills are required of the banks' staff and many have accepted their employers' offer to provide a PC for home use on condition of training in computer skills.

Another factor is the development of new products and distribution channels which the development of new technology has made it possible to offer and market. This creates new sources of income and potential cost savings. Particularly the PC-based self-service systems continue to gain ground. These systems save time for both parties, and usually the customer will pay a lower fee for the services. The Internet is also used more extensively, e.g. for marketing and issue of new publications. In some cases the banks and customers communicate directly via the Internet, e.g. in connection with loan applications.

The branch network is still important to Denmark's financial infrastructure, but the distance to the nearest branch is no longer the only parameter of competition for customers. The technological development has changed this, and the banks are continuously adjusting to a situation where customers can access prices and product descriptions from their desks at home, from where they can also establish contact with foreign banks. The erosion of sectoral barriers within the banking sector is expected to continue, among other factors in step with the technological development.

(to be continued)