The Domestic Financial System

In 1998 the minimum coupon rate was maintained at 4 per cent. As in 1997, 4-per-cent bonds for large amounts were issued. Mortgage-credit bonds for kr. 245 billion were converted, compared to kr. 260 billion in 1994, which was the last major conversion year.

The banks' total profit for the year rose to kr. 14 billion. Provisions and losses on debtors increased moderately and the provision ratio remained unchanged. The mortgage-credit institutes are expected to achieve a favourable annual result for the 4th consecutive year.

The bond market

Bond yields declined in 1998, except for the periods around the referendum on the Amsterdam Treaty in May and the turbulence on the international capital markets in August and September. The low interest rates made it attractive for home owners to convert their mortgage-credit loans. In 1998 mortgage-credit bonds for kr. 245 billion were redeemed prematurely, compared to kr. 260 billion in 1994, the last major conversion year.

The outstanding volume of krone-denominated bonds listed on the Copenhagen Stock Exchange rose in 1998 from a nominal amount of kr. 1,797 billion to kr. 1,876 billion. This net supply can be attributed to mortgage-credit bonds and other bonds, since the outstanding volume of government securities fell by kr. 10 billion.

The minimum coupon rate was maintained at 4 per cent in 1998 and is likewise fixed at 4 per cent for the first half of 1999. As in the previous year issues of 4-per-cent bonds were substantial. In 1998 the net supply of 4-per-cent bonds was around kr. 60 billion.

Non-resident investors acquired krone-denominated bonds for a net amount of kr. 2 billion in 1998. Their portfolios still mainly comprise government securities, although demand for mortgage-credit securities has been rising. Net purchases of mortgage-credit bonds by non-residents thus amounted to kr. 25 billion, while they resold government bonds for a net amount of kr. 26 billion.

In the 1999 Finance Act a measure was adopted to abolish the exemption from real-interest tax of yields on newly-issued index-linked bonds. This amendment entails that the obligation to finance subsidised housing by issuing index-linked bonds has lapsed. Issues of index-linked bonds will therefore decline considerably.⁽¹⁾

An innovation in the bond market was the issue of mortgage-credit bonds denominated in euro (up to 1 January 1999 in ECU).

The LTCM crisis
The Danish mortgage-credit market was affected significantly by the turbulence on the financial markets in the autumn of 1998, when demand for safe, liquid government bonds from the industrialised countries rose, leading to a significant decline in international bond yields. In Denmark too, investors' increased aversion to risk led to a significant widening of the yield differential between mortgage-credit and government bonds, cf. Chart 28.

The yield differential widened further in September 1998 when the US hedge fund, Long Term Capital Management, LTCM, was on the brink of bankruptcy, cf. p. 52ff. LTCM and other investors had also taken positions in the Danish mortgage-credit market. This led to concern that resales of mortgage-credit bonds might have a strong impact on price formation. From September to November non-residents resold mortgage-credit bonds for a net amount of kr. 25 billion. In December non-residents repurchased mortgage-credit bonds for net kr. 6 billion.

Chart 28 Yield differential between the mortgage-credit bond 6 per cent
2029 and the government bond 7 per cent 2007

The effects of the whitsun package on the capital market

As a measure to stimulate savings, before the summer break the Folketing (Parliament) adopted the Whitsun package of economic measures which contained a number of legislative amendments in the taxation area. The amendments to taxation of pension savings are of particular significance to the capital market since the real-interest tax is replaced by a new tax on pension returns:⁽²⁾

• On valuation of the taxation basis the previous realisation principle is replaced by mark-to-market.
• The variable real-interest-tax rate is replaced by a fixed capital-yield tax of 26 per cent.
• A tax of 5 per cent on equity returns is introduced.
• The ceiling for equity investments is raised to 50 per cent.

A committee has been appointed under the Ministry of Economic Affairs to investigate how portfolios are to be marked to market in practice.

The new Act on Taxation of Yields on Pension Savings is expected to contribute to improving the efficiency of the bond market. In some periods the real-interest tax has dampened the trading volume of bonds, making price formation less efficient. This inappropriate effect will disappear once the new taxation structure comes into force.

The transition to compilation of the taxation basis at market value means that in future bonds and derivatives will be taxed according to the same principle. This will remove a tax-related barrier to institutional investors' use of derivatives in their portfolio management.

The raising of the equity investment ceiling is an immediate incentive to increase investment in shares. The overall effect of the Whitsun package on the proportion of shares in institutional investors' portfolios can, however, not be determined clearly, since several counterbalancing effects are involved.

Valuing the taxation basis according to the realisation principle instead of by mark-to-market entails that changes in the level of interest rates and in share prices will have a direct impact on tax revenues. This implies that central-government revenue is more sensitive than before to fluctuations in stock-exchange prices.

Measures in the stock-exchange area

Nordic stock-exchange cooperation
In June 1997 the Copenhagen Stock Exchange and the Stockholm Stock Exchange initiated formalised cooperation, NOREX, with the purpose of establishing a joint Nordic securities market. Pursuant to this the two stock exchanges at the beginning of 1998 established a joint company, Nordic Exchanges A/S, whose primary task is to market NOREX to the rest of the world. As a consequence of this cooperation the Copenhagen Stock Exchange will introduce the Swedish trading system SAX 2000 for stock trading. The system is expected to be implemented in the 2nd quarter of 1999. In SAX 2000 a bond-trading system can also be developed. The Copenhagen Stock Exchange will select a system for trading of bonds in Denmark.

The securities depositories in Denmark (VP), Sweden (VPC) and Norway (VPS) have initiated cooperation to support closer Nordic partnership in thestock-exchangeareaandinpreparationforfuturewiderEuropeancooperation.DanmarksNationalbank,SverigesRiksbankandNorges Bank are together analysing how the central banks can support this initiative.

In the short term VP and VPC establish safekeeping depots with each other, whereby Danish investors can deposit Swedish securities in VP, and vice versa. Danmarks Nationalbank and Sveriges Riksbank support the exchange of periodic payments (interest, redemptions and dividends) on securities deposited with the securities centres.

In the longer term, the intention is to create a joint Nordic clearing and settlement system, S4 (Scandinavian Securities Settlement System). Under this system a participant will need only one connection to be linked up to the entire Nordic market. S4 participants may also be other countries besides the Nordic countries.

In mid-1998 the Nordic Council of Ministers took the initiative to investigate opportunities for closer Nordic cooperation in the securities area. The work concentrates on comparing the different regulatory frameworks. The aim is to assess the need for possible adjustment or harmonisation of the rules in order to strengthen the Nordic markets' international competitive position. No evaluation of business issues is made, since this is left to the market participants. The work is expected to be concluded in the first half of 1999.

European stock-exchange cooperation
In 1998 agreements were reached on closer cooperation between stock exchanges in many European countries. This is a consequence of several factors, particularly economies of scale and the introduction of the euro. Most significant is the agreement between the stock exchanges in Frankfurt and London on establishing a joint trading system for the largest European companies. In November 1998 the Helsinki Stock Exchange announced that it had initiated negotiations on establishing closer ties with the Frankfurt Stock Exchange. This will among other things entail that the Finnish stock exchange will use the German trading system Xetra.

The banks

The economic upswing of recent years is reflected in the banks' financial results. In 1998 the banks presented a sound surplus for the fourth consecutive year. The profit before tax was kr. 14 billion, which is an increase of kr. 1 billion against 1997.

Non-interest-based income has gained significance in step with the narrowing of the interest margin and the introduction of fees. This trend continued in 1998. Net income from fees rose by 18 per cent. A significant proportion can be attributed to the conversion of mortgage-credit loans and to capital management. The development towards earnings less dependent on interest means that net income from fees now constitutes around one fourth of the total net income from interest and fees, against only approximately 15 per cent at the beginning of the 1990s.

The banks' losses and provisions on debtors showed a moderate increase in 1998.

In December the Folketing (Parliament) adopted an act which continues the previous practice allowing banks and mortgage-credit institutes among others to base the calculation of taxable income on accounting provisions, and not solely on provisions for irrecoverable losses.

Danmarks Nationalbank has attached considerable importance to accounting provisions being used to value the taxation basis, since this gives the banks a clear incentive to make the required provisions.

Structural changes
The narrowing of the interest margin has caused the banks to increasingly widen their business scope with new products. During the past year a number of banks gave greater priority to areas such as capital management and securities trading.

During the year Danish banks furthermore intensified the fight for market shares in the Nordic market.

Structural changes also took place within the borders of Denmark. BG Bank and Realkredit Danmark formed a joint holding company, Kapital Holding. This amalgamation required amendment of the Danish Commercial Banks and Savings Banks Act, so that the requirement of limitation of voting rights for savings banks lapses five years after the restructuring.

Banking can be generally described as a very information-intensive activity. A large proportion of the functions performed by the banks is based on collecting, storing, processing, selling and distributing information. The sector is therefore strongly influenced by the rapid development of modern information technology. This will affect the supply of financial services and the way in which services are provided and distributed. In recent years the Internet, for example, has become important to banks' marketing and distribution activities.

Electronic money, e.g. the Danmønt prepaid card, is another example of changes in the wake of technological progress. In global terms, electronic money is still only issued on a very limited scale, and within Europe mainly by banks. In 1998 the European Commission proposed rules for other issuers of electronic money besides banks⁽³⁾. The Nationalbank has expressed its support in principle for the proposal, which takes into account that issuers of electronic money usually have a very different balance-sheet structure to that of banks.

The mortgage-credit institutes

In 1998 the mortgage-credit sector is expected to present a favourable financial result for the fourth consecutive year⁽⁴⁾. Lending rose by a considerable 8 per cent and conversion activity in 1998 was almost as high as during the conversion wave in 1994.

The new bank-owned mortgage-credit institutes again in 1998 acquired market shares from the old mortgage-credit institutes⁽⁵⁾. This applies in particular to the market for loans to private home owners. In 1998 the new mortgage-credit institutes accounted for almost 80 per cent of net new lending⁽⁶⁾ for owner-occupied homes and summer cottages, cf. Chart 29. Due to the banks' traditionally close contact with customers the new mortgage-credit institutes were able to use the many conversions to take over the customers' mortgage-credit loans.

Chart 29 Net new lending for owner-occupied homes and summer cottages

Note: Reported to Danmarks Nationalbank. Net new lending is calculated as gross new lending less premature redemptions.

Taken as one, the new mortgage-credit institutes saw an increase in total lending by kr. 52 billion in 1998, while the increase in lending by the old mortgage-credit institutes was kr. 27 billion. The new mortgage-credit institutes' share of total outstanding loans thus rose to 20 per cent in 1998, against 16 per cent in 1997.

The conversion activity of respectively new and old mortgage-credit institutes can be illustrated by relating the conversions in a mortgage-credit institute to the mortgage-credit institute's gross new lending⁽⁷⁾. In 1998 conversions accounted for 58 per cent of the gross new lending of the old mortgage-credit institutes, while the equivalent figure for the new mortgage-credit institutes was 44 per cent. The activity of the old mortgage-credit institutes was thus to a greater degree characterised by conversions of existing customer loans, while the new mortgage-credit institutes gained a greater share of the new customers in 1998.

The conversion activity can also be illustrated by extraordinary redemptions as a ratio of the circulating volume of conversion-ready bonds. Here there is a tendency for the new mortgage-credit institutes to have a slightly higher redemption ratio than the old mortgage-credit institutes.

The structural development in the mortgage-credit sector has entailed that especially old mortgage-credit institutes seek to offer all types of financial services. It is sought to realise this strategy either by mergers, acquisitions or cooperation with other financial enterprises.

Several mortgage-credit institutes have introduced euro-denominated loans, including loans with interest-rate adjustment. According to the mortgage-credit institutes, euro-denominated loans are intended primarily for business enterprises which have euro-denominated revenues.

The investment associations

The number of investment associations and their assets have increased significantly in the past three years. The low level of interest rates has served as an incentive to many savers to seek alternative placement opportunities to e.g. bank deposits. At the same time, price increases on the bond and share markets have contributed to growth in the investment associations' total assets. The total assets of investment asociations thus rose by kr. 34 billion to kr. 124 billion in 1998. Nominal sales of new certificates were kr. 29 billion, while capital gains on the investment associations' securities, etc. amounted to kr. 5 billion.

Chart 30 Assets of investment associations

Source: The Investment Associations Council.

In the 3rd quarter the market value of several share certificates fell by around 20 per cent, but prices rallied in part towards the end of the year. Investment associations based on European equity securities achieved a return of around 21 per cent, while investment associations based on Danish equity securities typically saw a drop of 4 per cent. Investment associations based on debt securities typically rose by 5-8 per cent. Bond units in particular have attracted investors in recent years, cf. Chart 30.

VB Finans and Himmerlandsbanken

At the end of 1993 the Nationalbank made available a government-guaranteed overdraft of maximum kr. 4.4 billion to VB Finans, the company responsible for the winding-up of Varde Bank. As described in the 1996 Annual Report, p. 54f, at the beginning of 1996 bankruptcy proceedings were instigated against VB Finans, at the request of its Board of Directors. VB Finans af 1996, which in connection with the winding-up took over all of VB Finans' assets and certain liabilities, including the Nationalbank's overdraft facility, worked throughout 1998 on winding up the activities of Varde Bank.

During 1998 the company was able to pay approximately kr. 0.2 billion to the Nationalbank as a consequence of the winding-up of exposures, sale of properties and divestment of shareholdings. The company's total debt to the Nationalbank has thus been virtually halved from almost kr. 0.4 billion at the beginning of the year to just below kr. 0.2 billion at year-end.

The accelerated winding-up meant that the Board of Directors of VB Finans af 1996 A/S could stand down in 1998. The winding-up is thus now to a great extent equivalent to ordinary estate administration by the trustees. The company still holds a number of assets to be wound up. The ongoing winding-up of the company first and foremost concerns a number of court cases filed against the winding-up estate. It is still not possible to calculate the total costs of the winding-up of Varde Bank.

In 1998 no amounts were disbursed under the guarantee provided by the Nationalbank and a number of banks to the winding-up estate of Himmerlandsbanken, cf. the 1993 Annual Report, p. 48ff. Final calculation of the costs of the winding-up of Himmerlandsbanken awaits the outcome of court cases filed against the estate.

Footnotes