The Financial Sector
The Danish banking institutions and the Nordic groups, including Danske Bank and Nordea, performed well in 2004. Though earnings were under pressure from lower interest margins, results were healthy, buoyed mainly by the historically low level of losses and provisions and rapidly expanding business volumes. The banking institutions thus benefited from the favourable domestic economic climate.
Costs rose in the large and small institutions, while decreasing in the Nordic groups.
Strong growth in lending entails increased exposure to losses, especially among small institutions. The Nordic groups appear more robust in 2004 than in 2003.
The decline in interest rates continued in 2004 to a very low level. Concurrently with this development, the banking institutions have reduced their interest-rate exposure – a trend which is most pronounced among the large institutions. It is important that the banking institutions are able to withstand both direct and indirect impacts of potential increases in interest rates.
The capital adequacy of the Danish banking institutions have decreased, but remain unchanged for the Nordic groups.
NORDIC GROUPS AND DANISH BANKING INSTITUTIONS
Earnings
Both the Nordic groups, category A, and the Danish banking institutions in categories B and C[1] recorded historically high results in 2004 – not allowing for the proceeds from the sale of Totalkredit shares.[2]
The pre-tax profit of the Nordic groups was kr. 70.4 billion, equivalent to a 26 per cent rise on 2003. Return on equity (ROE) increased from 13.7 to 16.2 per cent, see Table 1.[3]
| PROFITS BEFORE TAX, 2003 AND 2004 |
Table 1
|
|||||
|
Nordic groups,
category A |
Danish banking
institutions, category B |
Danish banking
institutions, category C |
||||
| Kr. billion |
2004
|
2003
|
2004
|
2003
|
2004
|
2003
|
| Income |
|
|
|
|
|
|
| Net interest income |
94.7
|
99.4
|
10.0
|
10.0
|
2.2
|
2.1
|
| Net fee and commission income |
43.2
|
39.3
|
4.1
|
3.6
|
0.8
|
0.7
|
| Value adjustment of securities, etc. |
6.9
|
4.6
|
2.4
|
2.7
|
0.5
|
0.8
|
| Value adjustment of capitalinvestments |
6.1
|
5.2
|
0.8
|
0.2
|
0.1
|
0.1
|
| Other ordinary income |
10.0
|
6.2
|
0.3
|
0.9
|
0.1
|
0.1
|
| Costs |
|
|
|
|
|
|
| Operating expenses, etc. |
89.2
|
91.0
|
10.0
|
9.4
|
2.1
|
2.0
|
| Losses and provisions |
1.4
|
8.3
|
1.1
|
1.8
|
0.3
|
0.5
|
| Profit before tax |
70.4
|
55.8
|
6.5
|
6.3
|
1.3
|
1.4
|
| Of which proceeds (Totalkredit) |
-
|
-
|
0.6
|
1.7
|
0.2
|
0.5
|
| ROE after tax, per cent |
16.2
|
13.7
|
14.9
|
15.9
|
13.1
|
16.1
|
| Market share of Danish lending, per cent |
53.1
|
54.4
|
26.7
|
25.5
|
4.5
|
4.3
|
| Note: For the purpose of currency translation of financial figures for the Nordic groups, an average of the exchange rates for the year is used as far as profit and loss accounts are concerned. For translation of balance sheets, exchange rates at year-end are applied. The market share is measured in terms of lending to domestic residents. Adjustment is made for mortgage-credit lending for the Nordic groups. The total market share of categories A, B and C amounts to 84.3 per cent in 2004. The remaining market shares are distributed on institutions not included in categories A, B or C, e.g. FIH and a number of small institutions. Source: Annual accounts and Danmarks Nationalbank. |
||||||
|
Box 1
|
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|
The analyses are based on the annual accounts of 52 selected banking groups and banking institutions, divided into Nordic groups (category A), large Danish banking institutions (category B) and small Danish banking institutions (category C). The banking institutions have been selected and grouped on the basis of their status at end-2003. They are assumed to belong to the same categories prior to end-20031. |
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|
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
The rationale for including the Nordic groups as an independent category is that the largest Nordic banking groups to a large extent have a pan-Nordic orientation, which is reflected in their exposures. Moreover, the largest Nordic banking groups are comparable in terms of business areas and sizes, cf. the chapter on analysis of bank equity prices. If the text or the Charts refer to "Danish banking institutions", the aggregate of categories B and C, as well as Danske Bank A/S and Nordea Danmark A/S, is applied. Analyses made on the basis of "Danish banking institutions" are typically performed where the information provided in the annual accounts of the other Nordic groups is insufficient. Finally, in a few analyses, ad-hoc categories are used, based on available data. This is specified in the notes of the respective Charts and Tables. |
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| 1 The figures may deviate from previous reports. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
The earnings in categories B and C were largely unchanged compared to 2003. Adjusted for the proceeds from the sale of Totalkredit shares, earnings increased by 28 and 41 per cent, respectively. ROE was just under 15 per cent in category B and just over 13 per cent in category C.
As high growth in lending has not compensated for declining interest margins in category A, net interest income has decreased. In category C, which recorded the strongest growth in lending, net interest income shows a modest increase.
The average lending rate of the banking institutions has fallen in response to strong growth in lending collateralised by real estate ("prioritetslån") in 2004, among other factors. At the same time, low interest rates have made it impossible for the banking institutions to lower their deposit rates in step with the decline in the money-market rate (so-called floor risk), cf. Chart 1. This exerts pressure on the interest margin of the banking institutions.
| AVERAGE DEPOSIT AND LENDING RATES, MONEY-MARKET RATE AND NET INTEREST INCOME, DanISH BANKING INSTITUTIONS, 2001-04 |
Chart 1
|
 |
|
| Note: The money-market rate is a reference rate for providing liquidity in the inter-bank market (in Copenhagen) on an uncollateralised basis. The money-market rate is a day-to-day rate. | |
| Source: Annual accounts and Danmarks Nationalbank. | |
Fee and commission income has risen for all three categories in 2004, driven mainly by higher income from trading activities and payment services. Fee income accounts for an increasing proportion of total net interest and fee income, close to 30 per cent in 2004.
The Nordic groups reduced their cost ratios from 58.8 per cent of income in 2003 to 55.4 per cent in 2004 as a result of higher business volumes and staff reductions. For banking institutions in categories B and C, costs rose by 7 and 6 per cent, respectively, in response to an increase in the number of employees in the two categories, among other factors. Moreover, some institutions opened new branches in 2004. If the proceeds from the sale of Totalkredit shares are not included, the cost ratios showed a modest decline from 2003 to 2004 for categories B and C. In category B, 10 per cent of the institutions recorded a cost ratio exceeding 71 per cent, while the corresponding figure for category C was 69 per cent.
Banking institution results in 2004 are underpinned e.g. by the low level of losses and provisions. More than 90 per cent of the institutions in categories B and C recorded losses and provisions of less than 1 per cent in 2004, cf. Chart 2, and a few institutions even had net reversals.
| LOSSES AND PROVISIONS AS A RATIO OF LOANS AND GUARANTEES, CATEGORIES A, B AND C, 2001-04 |
Chart 2
|
 |
|
| Source: Annual accounts. | |
Historically, periods of high lending growth have often been followed by rising losses and provisions, indicating that credit quality tends to deteriorate during periods of high lending growth.
However, the high lending growth in the late 1990s has not resulted in increased losses and provisions to the same extent as previously. A possible explanation is that the economic decline in 2002 and 2003 was relatively modest, causing the rate of unemployment to rise only slightly.
Moreover, other vital factors, such as property prices, developed favourably. Unemployment can be seen as an expression of general macroeconomic conditions, and unemployment and losses and provisions match each other closely, cf. Chart 3.
| UNEMPLOYMENT AND BANKING INSTITUTIONS' LOSSES AND PROVISIONS, 1976-2004 |
Chart 3
|
 |
|
| Note: The Chart is based on data from all banking institutions of the Danish Financial Supervisory Authority's categories 1, 2 and 3. | |
| Source: The Danish Financial Supervisory Authority and Statistics Denmark. | |
A number of technical and structural factors may have changed the correlation between lending growth and losses and provisions. The banking institutions may, for example, have enhanced their risk management through more sophisticated models developed in view of the introduction of the new capital-adequacy rules, Basel II, cf. the chapter on framework conditions for the financial system.
Moreover, new international accounting standards, IAS/IFRS, were introduced on 1 January 2005, cf. the same chapter. The new accounting standards entail a transition from the Danish prudential accounting principle to a neutrality principle for credit institutions' valuation. This will translate into a reduction of the institutions' provisions[4]. The reduction appears from the opening balance sheets of the institutions for the 2005[5] financial year. There is a wide gap in the percentage reductions in accumulated provisions resulting from the new accounting rules – ranging from zero impact to a 41 per cent reduction. It cannot be ruled out that the introduction of the new accounting rules has already exerted downward pressure on the level of provisions in recent years and will continue to have an impact. Thus the adjustment to the new accounting rules will be gradual.
Lending growth
The banking institutions in categories B and C, in particular, experienced significant growth in lending in 2004, cf. Chart 4. The figures cover great variation from one institution to the next, however, ranging between 0 and 46 per cent. The 10 per cent of the banking institutions in category B with the strongest growth in lending saw an increase above 38 per cent, while the corresponding figure for category C was above 37 per cent. These figures represent a significant increase on the 2003 figures of 14 and 21 per cent, respectively.
| ANNUAL GROWTH IN LENDING, CATEGORIES A, B AND C, 2002-04 |
Chart 4
|
 |
|
| Note: Growth is calculated as a weighted average of the increase in lending in each of the three categories. The growth ratios of the Nordic groups allow for foreign-exchange adjustments, FöreningsSparbanken's (Swedbank) sale of FIH in 2004 and DnB NOR's sale of Elcon in 2004. | |
| Source: Annual accounts. | |
The high growth in lending stems from both the corporate sector and the households. One of the key reasons for the strong growth in lending to households is an increase in home-financing loans ("prioritetslån") granted against real property as collateral and thus subject to relatively low risk. With these loans, a lending and a deposit account are set up in the borrower's name on the same interest-rate terms, typically at a higher rate than the rate on a mortgage-credit loan granted by a mortgage-credit institute.
|
Box 2
|
|
|
FIH acquired by Kaupthing Bank Danske Bank acquires National Irish Bank and Northern Bank |
|
Capital structure
The capital adequacy in categories B and C decreased from 2003 to 2004, cf. Chart 5. The solvency ratio is unchanged for the Nordic groups, while the core capital (tier 1 capital) has increased. Since 2003, the Danish banking institutions have been able to issue loan capital that may be included in the core capital, i.e. hybrid core capital, cf. Box 3, and several banking institutions have availed themselves of this opportunity.
| CORE CAPITAL AND SOLVENCY RATIOS, CATEGORIES A, B AND C, 2001-04 |
Chart 5
|
 |
|
| Source: Annual accounts. | |
|
Box 3
|
|
|
Since 2003, banking institutions have been allowed to issue hybrid core capital which may be included in core capital provided, among other factors, that the following conditions are met:
Hybrid core capital is regulated by section 132 of the Danish Financial Business Act. |
|
| Note: For further details on hybrid core capital, see: Bundgaard, Birgitte and Suzanne Hyldahl, Structure of the Banks' Capital – New Statutory Requirements and Opportunities, Danmarks Nationalbank, Monetary Review, 3rd Quarter 2002. | |
Accumulated provisions on loans and guarantees, along with the portion of the capital exceeding the statutory 8 per cent requirement, constitute the banking institutions' total buffer to withstand losses. Overall, the Danish banking institutions' total buffer as a ratio of loans and guarantees was reduced in 2004. The reduction is a result of lower solvency ratios and a fall in accumulated provisions, both in absolute terms and as a ratio of loans and guarantees, cf. Chart 6.
| BANKING INSTITUTIONS' BUFFER AS A RATIO OF LOANS AND GUARANTEES, 1996-2004 |
Chart 6
|
 |
|
| Note: The Chart includes all banking institutions in the Danish Financial Supervisory Authority's categories 1-4. Excess cover is capital in excess of the 8 per cent requirement. | |
| Source: The Danish Financial Supervisory Authority. | |
As already mentioned, the new IAS/IFRS accounting standards, effective from 1 January 2005, and the future capital-adequacy rules, Basel II, will both have an impact on the size and composition of the future buffers of the banking institutions.
RISK FACTORS FACING DANISH BANKING INSTITUTIONS
Assessment of the banking institutions' credit risks
Danmarks Nationalbank's failure-rate model, cf. the chapter on the corporate sector and the households, can be used to analyse the credit risk on the lending portfolios of the Danish banking institutions. To that end, a credit-risk measure is established that can be used to rank the banking institutions according to the degree of credit risk on their lending portfolios. The higher the credit-risk measure, the higher the credit risk of the lending portfolio, cf. Box 4.
|
Box 4
|
|
|
The calculation is based on Danmarks Nationalbank's failure-rate model, which estimates Danish public and private limited liability companies, cf. the chapter on the corporate sector and the households. 59 per cent of the companies in the failure-rate model provide information about which bank they use. The analysis includes only banking institutions serving at least 30 companies in 2004, a total of 42 banking institutions. The lending ratios of each individual banking institution – both at sector level and to households – are disclosed in their annual accounts. As an approximation for the estimated failure rate of the households (Phouseholds) and the agricultural sector (Pagriculture)1, the current year's average loss ratios for each of the two groups are used. Subsequently, an overall credit-risk measure is calculated for the lending portfolio of the individual banking institution. The calculation of the credit risk of banking institution i on its lending portfolio is based on the formula: Picorporate is the weighted estimated failure rate of the companies using banking institution i. The estimated failure rate of the individual company served by the individual banking institution is weighted by the debt of the enterprise relative to the debt of all companies served by the individual banking institution. Ui is the lending ratio of banking institution i to the corporate sector (excluding agriculture), households and agriculture, respectively. |
|
| 1 The loss ratio is losses as a ratio of loans and guarantees. The 2004 loss ratio is assumed to be equal to the loss ratio a year earlier. | |
Chart 7 shows the credit-risk measure for each of the Danish Financial Supervisory Authority's banking-institution categories in 2002 and 2004. The credit risk on the lending portfolio is lowest for category 1, and it has declined since 2002. In 2004, the credit risk was highest for the banking institutions in category 2, and the median has risen since 2002. In 2004, the largest dispersion was in category 3.
| 10TH, 50TH AND 90TH PERCENTILES FOR CREDIT RISK ON THE LENDING PORTFOLIOS IN THE DANISH FINANCIAL SUPERVISORY AUTHORITY'S BANKING INSTITUTION CATEGORIES 1-3, 2002 AND 2004 |
Chart 7
|
 |
|
| Note: The banking institutions are classified according to the Danish Financial Supervisory Authority's grouping of banking institutions in categories 1-3. | |
| Source: Own calculations. | |
As previously mentioned, the banking institutions in general increased their lending growth in 2004 and the number of banking institutions recording lending growth of more than 10 per cent increased considerably from 2003 to 2004. The analysis shows that banking institutions with relatively high lending growth have the highest credit risk on their lending portfolios, cf. Chart 8.
| 10th, 50TH AND 90TH PERCENTILEs FOR CREDIT RISK ON THE LENDING PORTFOLIOS OF BANKING INSTITUTIONS AND LENDING GROWTH, 2004 |
Chart 8
|
 |
|
| Note: The 10th percentile indicates that 10 per cent of the banking institutions have a credit-risk measure lower than or equal to the value in question. The median indicates that 50 per cent of the banking institutions have a credit risk higher than the value in question. 10 per cent of the banking institutions have a credit-risk measure higher than or equal to the 90th percentile. | |
| Source: Own calculations. | |
Banking institutions with a high credit risk on their lending portfolios also have higher non-performing credit over credits and provisions[6], cf. Chart 9. In general, non-performing credit over credits and provisions has, however, decreased in recent years.
| BANKING INSTITUTIONS' CREDIT RISK ON THEIR LENDING PORTFOLIOS AND NON-PERFORMING LOANS, 2002-04 |
Chart 9
|
 |
|
| Note: Non-performing credit over credits and provisions are the Danish Financial Supervisory Authority's key performance indicator 12 for banking institutions. The banking institutions are classified according to credit-risk measure with 50 per cent in each category. | |
| Source: The Danish Financial Supervisory Authority and own calculations. | |
Uncollateralised day-to-day money market
The banking institutions and the mortgage-credit institutes have claims on other credit institutions, of which some are in the uncollateralised day-to-day money market for Danish kroner. Table 2 shows the average exposure in 2004 among credit institutions in the uncollateralised day-to-day money market, calculated on the basis of transactions in Danmarks Nationalbank's payment system, Kronos[7].
| AVERAGE DAILY EXPOSURE PER CREDIT INSTITUTION IN THE UNCOLLATERALISED DAY-TO-DAY KRONE MONEY MARKET IN 2004 |
Table 2
|
|||||
| Lending by institutions, kr. million |
To
cate- gory A |
To
cate- gory B |
To
cate- gory C |
To other
Danish credit institu- tions |
To
foreign credit- institu- tions, excl. Nordic groups |
Total
|
| Category A |
392
|
176
|
10
|
12
|
124
|
714
|
| Category B |
38
|
31
|
4
|
13
|
7
|
94
|
| Category C |
1
|
2
|
1
|
0
|
0
|
4
|
| Other Danish credit institutions |
11
|
11
|
2
|
1
|
6
|
30
|
| Foreign credit institutions, excl. Nordic groups |
70
|
35
|
0
|
0
|
14
|
120
|
| Source: Danmarks Nationalbank. | ||||||
Each group in category A has an average daily exposure of kr. 714 million to other credit institutions, more than 50 per cent of which is towards other category A groups. On average, foreign credit institutions, not including Nordic groups, have just over 12 per cent of the market for uncollateralised day-to-day money-market loans denominated in Danish kroner. Average amounts cover a significant variation between days and institutions. Table 3 shows the highest average exposure per credit institution in 2004 for the various categories. For the Nordic groups in category A, the maximum exposure is just under kr. 3 billion, or more than four times the average daily exposure.
| MAXIMUM DAILY EXPOSURE PER CREDIT INSTITUTION IN THE UNCOLLATERALISED DAY-TO-DAY KRONE MONEY MARKET, 2004 |
Table 3
|
| Kr. million |
Maximum
exposureper credit institution (average for the category) |
| Category A |
2,950
|
| Category B |
627
|
| Category C |
47
|
| Other Danish credit institutions |
273
|
| Foreign credit institutions, excluding Nordic groups |
722
|
| Source: Danmarks Nationalbank. | |
Foreign exposure
Geographically, Danish credit institutions are exposed mainly to the other Nordic countries, which is also the case for the institutions of the other Nordic countries, cf. Chart 10, thus suggesting that a relatively high degree of integration exists between the Nordic financial markets. A number of these exposures are exposures within the Nordea group. As far as other countries are concerned, the Danish institutions are relatively more exposed to the UK, whereas the other Nordic countries are more exposed to Germany and North America.
| CREDIT INSTITUTIONS' FOREIGN CLAIMS CALCULATED ON A CONSOLIDATED BASIS, END-SEPTEMBER 2004 |
Chart 10
|
 |
|
| Note: For the portion of data relating to Norwegian credit institutions' foreign claims, the most recent data available are from March 2004. | |
| Source: BIS. | |
Interest-rate risk
The interest-rate risk of the banking institutions is measured in terms of the proportion of the core capital (tier 1 capital) that is lost on a parallel shift in the yield curve of 1 percentage point[8], cf. Chart 11.
| INTEREST-RATE RISK: PROPORTION OF CORE CAPITAL LOST IN CASE OF A1-PERCENTAGE-POINT RISE IN INTEREST RATES, CATEGORIES B AND C, 2001-04 |
Chart 11
|
 |
|
| Note: Category A is not included in the Chart, since groups based outside Denmark do not calculate the key performance indicator "interest-rate risk", on which the calculations of the Chart are based. The figures are weighted averages. | |
| Source: Annual accounts and own calculations. | |
In general, the banking institutions in categories B and C have been reducing their interest-rate exposure since 2001 in step with the general decline in interest rates. The institutions in category C still have a relatively high interest-rate exposure, however. In category B, 10 per cent of the institutions had an interest-rate risk exceeding 5.6 per cent in 2004, while 10 per cent of the institutions in category C had an interest-rate risk exceeding 5.4 per cent.
For comparison, Danske Bank A/S and Nordea Danmark A/S compiled their interest-rate risk at 0.6 and 3.0 per cent, respectively, at the end of 2004, compared with 2.2 and 6.8 per cent a year earlier. Interest rates are very low and it is vital that the banking institutions have sufficient capital to withstand both direct and indirect impacts of any interest-rate rises.
The chapter on financial markets elaborates on market expectations of interest rates.
STRESS TESTING OF THE NORDIC GROUPS AND THE DANISH BANKING INSTITUTIONS
The resilience of the banking institutions to a number of hypothetical scenarios is analysed through stress tests. The implications of, respectively, an interest-rate rise, higher losses and the failure of the most important counterparty in the uncollateralised day-to-day money market are specifically analysed below. The stress tests are static and cover a period of one year. Thus no allowance is made for the possibility of the banking institutions adjusting to the scenarios. Therefore, the stress tests are not suitable for analysing the resilience of the institutions in the longer term.
In 1992 and 1993, the Danish banking institutions' losses and provisions amounted to, respectively, 2.5 and 2.4 per cent on average of total loans and guarantees. Chart 12 shows the development in losses and provisions in the troubled years in the early 1990s.
| BANKING INSTITUTIONS' ANNUAL LOSSES AND PROVISIONS AS A RATIO OF LOANS AND GUARANTEES IN THE PERIOD 1986-98 |
Chart 12
|
 |
|
| Note: The Chart is based on data for all banking institutions in the Danish Financial Supervisory Authority's categories 1-4. | |
| Source: The Danish Financial Supervisory Authority and own calculations. | |
This is the rationale for the choice of scenarios in the stress tests, under which losses are increased by up to 2.5 percentage points. As will appear from the 90th percentile of the Chart, several banking institutions suffered significantly higher losses during the period in question.
As a result of the strong growth in lending and less revenue from the sale of Totalkredit shares than in 2003, the banking institutions in categories B and C have become more exposed to higher losses compared with 2003, cf. Table 4. Failure of the most important counterparty on the worst day imaginable of 2004 would have affected a large portion of the banking institutions in categories B and C. The category B institutions have become less exposed to interest-rate rises, reflecting that, overall, they have reduced their interest-rate exposure, while the impact on the small institutions remains unchanged.
| NUMBER OF BANKING INSTITUTIONS AND GROUPS WITH NEGATIVE RESULTS BEFORE TAX, CATEGORIES A, B AND C, 2003-04 |
Table 4
|
|||||
| Scenarios |
Category A
|
Category B
|
Category C
|
|||
|
2004
|
2003
|
2004
|
2003
|
2004
|
2003
|
|
| Basis, ordinary operating result |
0
|
0
|
0
|
0
|
0
|
0
|
| Credit risk | ||||||
| 1 An increase in losses by 1 per- centage point |
0
|
0
|
0
|
1
|
0
|
0
|
| 2 An increase in losses by 2.5 per- centage points |
6
|
6
|
16
|
10
|
22
|
14
|
| 3 An increase in losses by 1 per- centage point for households and 2.5 percentage points for corporate customers |
6
|
6
|
9
|
6
|
7
|
0
|
| 4 Failure of largest counterparty bank in uncollateralised day-to- day money market |
0
|
na.
|
12
|
na.
|
11
|
na.
|
| Interest-rate risk | ||||||
| 5 An increase in interest rates by 1 percentage point |
na.
|
na.
|
0
|
0
|
0
|
0
|
| 6 An increase in interest rates by 3 percentage points |
na.
|
na.
|
4
|
5
|
6
|
6
|
| Combinations | ||||||
| 7 Scenarios 1 and 5 simultaneously |
na.
|
na.
|
4
|
4
|
1
|
1
|
| 8 Scenarios 2 and 6 simultaneously |
na.
|
na.
|
17
|
17
|
27
|
24
|
| 9 Scenarios 3 and 4 simultaneously |
na.
|
na.
|
17
|
na.
|
18
|
na.
|
| Total number of institutions |
6
|
6
|
18
|
18
|
28
|
28
|
| Note: Scenario 4, failure of the largest counterparty bank in the uncollateralised day-to-day money market, includes only accounts between institutions holding a current account with Danmarks Nationalbank. Source: Annual accounts, Danmarks Nationalbank and own calculations. |
||||||
In scenario 2, in which losses are increased by 2.5 percentage points, all six Nordic groups will experience negative results. However, none of the groups will fall below the statutory 8 per cent solvency requirement. In category B, four institutions will be unable to meet the solvency requirement under scenario 4, failure of counterparty banks, while only two institutions in category C will have problems meeting the solvency requirement. Overall, one and ten institutions in categories B and C, respectively, will be unable to meet the solvency requirements under scenarios 8 and 9.
The part of the banking institutions' capital that exceeds the statutory 8 per cent requirement helps to ensure that operations can continue in situations of rising, unexpected losses. In Chart 13, banking institutions with a solvency ratio below 8 are shown as a function of the increase in losses.
| NUMBER OF BANKING INSTITUTIONS IN CATEGORIES B AND C WITH A SOLVENCY RATIO BELOW 8 ON AN INCREASE IN LOSSES ON LOANS AND GUARANTEES, 2003-04 |
Chart 13
|
 |
|
| Source: Annual accounts and own calculations. | |
It is not until losses rise by 4 percentage points that the solvency ratio falls below 8 in one category B institution.
Chart 14 illustrates the same situation, the only difference being that the institutions are included with their total assets. This gives an idea of the size of the institutions with a solvency ratio below 8.
| TOTAL ASSETS OF BANKING INSTITUTIONS IN CATEGORIES B AND C WITH A SOLVENCY RATIO BELOW 8 ON AN INCREASE IN LOSSES ON LOANS AND GUARANTEES, 2003-04 |
Chart 14
|
 |
|
| Note: Total assets for the institutions in categories B and C, Danske Bank and Nordea Danmark amounted to kr. 2,195 billion at end-2004 and kr. 2,026 billion at end-2003. The amount at end-2004 is equal to 100 per cent on the y axis. Adjustments have been made for an estimate of Danske Bank's activities abroad. | |
| Source: Annual accounts and own calculations. | |
If losses go up by 5 percentage points, six banking institutions whose total assets exceed 10 per cent of the total assets of the Danish banking institutions are affected. The two Charts show that, compared with 2003, the banking institutions have become marginally more exposed to an increase in losses. However, contrary to the situation in 2003, banking institutions with small assets are now most at risk.
As far as the Nordic groups are concerned, losses must rise by 3 percentage points in 2004 before any groups fall below the solvency requirement. A year earlier, the corresponding figure was 2.5 percentage points. Thus the Nordic groups have overall become more robust. The most robust groups will not fall below the solvency requirement unless their losses rise by 4.5 percentage points.
MORTGAGE-CREDIT INSTITUTES
Mortgage-credit institutes play an important role in the Danish financial sector – partly by acting as key credit providers in connection with property financing and partly by serving as bond issuers. At end-2004, the mortgage-credit debt of households totalled kr. 1,141 billion, equivalent to approximately 70 per cent of household liabilities. The total outstanding volume of mortgage-credit bonds amounted to kr. 1,806 billion at end-2004, equivalent to just over 70 per cent of the Danish bond market.
The earnings of the mortgage-credit institutes are comprised mainly of regular commissions fromborrowers, remortgaging fees and portfolio earnings. In 2004, the mortgage-credit institutes achieved profits before tax of slightly over kr. 9 billion, which is on a par with 2003. While 2003 saw a flurry of remortgaging activity, 2004 was characterised by conversion to deferred-amortisation loans and, towards the end of the year, by the introduction of adjustable-rate loans with an interest-rate cap. Gross new lending by mortgage-credit institutes totalled just under kr. 440 billion in 2004, while the high remortgaging activity in 2003, prompted by the low level of interest rates, led to the highest ever gross new lending at kr. 512 billion.
The proportion of adjustable-rate loan issues relative to traditional fixed-interest loans continues to increase. Variable-rate loans with an interest-rate cap, introduced in late 2004, have become popular, since loans worth more than kr. 60 billions have already been issued.
Mortgage-credit institutes' buffer against losses is illustrated in Chart 15. In 2004, the sector as a whole was able to withstand losses of 2.9 per cent. Actual losses and write-downs amounted to 0.0 per cent of the lending portfolio.
| MORTGAGE-CREDIT INSTITUTES' BUFFER AGAINST LOSSES, 1990-2004 |
Chart 15
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| Note: Maximum losses are compiled including actual losses and write-downs. Capital base data for 1990 are not available. | |
| Source: The Danish Financial Supervisory Authority and annual accounts. | |
The banking institutions' sales of mortgage-credit products are in some cases linked to a guarantee vis-à-vis the mortgage-credit institute. The banking institution provides a guarantee for the "last-ranking" part of the mortgage-credit loan for a limited number of years against guarantee commission[9]. In practice, under the guarantee system the intermediary banking institution assumes most of the credit risk associated with the mortgage-credit loan.
Pension Companies
Life-insurance companies and pension funds, jointly referred to as pension companies, form part of the Danish financial sector and may affect the banking institutions both directly, for instance through ownership, and indirectly, for example through the financial markets.
Higher global equity prices and declining interest rates in the euro area and Denmark meant that, in general, the pension companies achieved a higher return on investments in 2004, cf. Chart 16. Virtually all pension companies recorded a return equal to or higher than the maximum interest-rate guarantee given to policyholders of 4.5 per cent after tax. According to the annual reports published before contributions to this report were finalised,[10] few pension companies experienced problems with the yellow-light stress test scenario of the Danish Financial Supervisory Authority at the close of 2004.
| RETURN AFTER TAX IN THE PENSION COMPANIES, 1999-2004 |
Chart 16
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| Note: A number of pension companies had not published their annual accounts for 2004 before contributions to this report were finalised. Therefore, the 2004 figures are estimates, based on a number of published annual accounts. | |
| Source: The Danish Financial Supervisory Authority and annual accounts. | |
For the pension companies, declining interest rates in 2004 generated significant capital gains on their bond portfolios. However, lower interest rates are a double-edged sword for the pension companies. Firstly, because lower interest rates entail re-investing at a lower rate, which, in the longer term, serves to reduce the companies' current returns. Secondly, because the liabilities of the pension companies are typically more exposed to interest-rate changes than their assets, implying that an interest-rate decline may eventually make it more difficult for the pension companies to fulfil their obligations. To several pension companies, the interest-rate risk of their liabilities is closely linked to nominal interest-rate guarantees previously given. From 1982 until mid-1994, the pension companies were thus free to guarantee the pension savers a minimum annual return after tax of 4.5 per cent over the life of the pension. In 1994, the Danish Financial Supervisory Authority lowered the rate to 2.5 per cent, followed by a further lowering, to 1.5 per cent, in 1999.
In step with the general decline in Danish interest rates, the 4.5 per cent guarantees, in particular, have become difficult to meet. Throughout most of the 1990s and until today, the yield on the 10-year government bond after tax has thus not been able to cover the 4.5 per cent guarantees, cf. Chart 17. Consequently, many pension companies have chosen to hedge their interest-rate risk either fully or partly through financial instruments.
| MAXIMUM GUARANTEED INTEREST RATES AND YIELD TO MATURITY OF A 10-YEAR GOVERNMENT BOND AFTER PENSION-FUND TAX / REAL INTEREST TAX, 1988-2005 |
Chart 17
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| Note: As from 2000, the Pension-Fund Tax Act replaced the Real Interest Tax Act. The maximum guaranteed interest rates are shown after deduction of expense and contingency loading, typically of 0.5 percentage points. | |
| Source: The Danish Financial Supervisory Authority, the Danish Ministry of Taxation and Danmarks Nationalbank. | |
With bonds accounting for 72 per cent of the investment assets, the current low level of interest rates means that the pension companies must increasingly rely on the return on other investment assets to meet the interest-rate guarantees in the longer term. In 2004, the pension companies decided to increase their equity portfolios at the expense of bonds, cf. Chart 18. At the same time, the pension companies reduced their holdings of domestic assets, in the form of equities as well as bonds, to acquire foreign assets.
| DEVELOPMENT IN THE PENSION COMPANIES' INVESTMENT ASSETS, 1998-2004 |
Chart 18
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| Note: A number of pension companies had not published their annual accounts for 2004 before contributions to this report were finalised. Therefore, the 2004 figures are estimates, based on a number of published annual accounts. Other investment assets are not included. | |
| Source: Annual accounts and the Danish Financial Supervisory Authority. | |
[1] See Box 1 for a definition of the categories.
[2] In November 2003, Nykredit acquired Totalkredit, which was owned by 106 local and regional banking institutions, in what was partly a cash payment and partly a conditional payment over a number of years. The listed banking institutions' estimates of the capital gain on the sale total kr. 3.4 billion, just over 50 per cent of which was recognised in 2003.
[3] For comparison, the return on equity after tax for banks in the euro area was 6.7 per cent in 2003. According to preliminary figures for 2004, ROE after tax is 8.3 per cent. Source: ECB, Financial Stability Review, December 2004.
[4] In future, provisions will be replaced, for accounting technical purposes, by write-downs on the loan in question.
[5] The opening balance sheets have yet to be published, but most institutions have commented on the effect in their annual reports for 2004.
[6] The Danish Financial Supervisory Authority's key performance indicator 12 for banking institutions.
[7] The method is described in Danmarks Nationalbank, Financial stability 2004 and in Abildgren, Kim and Henrik Arnt, The Activity in the Danish Money Market, Danmarks Nationalbank, Monetary Review, 2nd Quarter 2004.
[8] Calculated on the basis of the Danish Financial Supervisory Authority's key performance indicator 6, interest-rate risk over tier 1 capital.<0}
[9] For owner-occupied housing mortgaged at 80 per cent of the property value, the banking institutions may e.g. guarantee the last-ranking 20 percentage points.
[10] The Danish Financial Supervisory Authority has developed two stress testing scenarios, the red and the yellow risk scenarios, which the pension companies are required to report to the Danish Financial Supervisory Authority. The red risk scenario assumes a change in interest rates of 0.7 percentage points in the direction entailing the highest losses; a fall in stock prices by 12 per cent; a decline in real estate prices by 8 per cent; and losses in connection with credit, counterparty and exchange-rate risks. The yellow risk scenario assumes a change in interest rates by 1.0 percentage point in the direction entailing the highest losses; a fall in stock prices by 30 per cent; a decline in property prices by 12 per cent; and losses in connection with credit, counterparty and exchange-rate risks.