Report on Danmarks Nationalbank's Accounts
Danmarks Nationalbank's financial risks mainly comprise market risks. The exposure primarily relates to interest rates but also to exchange rates and the gold price. The exchange-rate sensitivity primarily concerns assets denominated in euro. The credit risk is very small. Danmarks Nationalbank seeks to completely avoid credit losses by exclusively holding claims on counterparties with a high credit standing, and by requiring pledging of collateral to a significant degree. At the close of 2003 Danmarks Nationalbank's market risk, measured by Value-at-Risk, totalled kr. 3.3 billion in a one-year perspective. This is virtually unchanged from 2002.
Danmarks Nationalbank's accounts for 2003 show a profit of kr. 3.6 billion, compared to kr. 6.7 billion in 2002. This adjustment is due mainly to the decline in value adjustments, etc. by kr. 2.4 billion to kr. ‑0.3 billion. Of the profit for the year, kr. 3.1 billion is payable to the central government, kr. 0.3 billion is allocated to the Value Adjustment Reserve, and kr. 0.8 billion is allocated to the General Reserves.
Danmarks Nationalbank's management of financial risks
Danmarks Nationalbank's financial result depends on several uncertainties, primarily the development in a number of financial markets, but also counterparties' ability and willingness to meet their payment obligations.
To a certain extent, Danmarks Nationalbank's financial risks are a result of its role as monetary authority which includes managing the monetary and foreign-exchange policy, issuing banknotes and coins and functioning as banker to the banks and to the central government. The risks arising from the role as monetary authority are unavoidable. For example, it is necessary to hold a foreign-exchange reserve in order to conduct a fixed-exchange-rate policy. Other risks reflect that Danmarks Nationalbank as a financial business seeks to achieve a good return. For instance, the interest-rate risk is incurred on the basis of weighing the expected earnings against risk.
Danmarks Nationalbank's choice of risk level is characterised by prudence. A low level of risk makes it possible to maintain a high degree of solvency even in periods of extreme market conditions.
Danmarks Nationalbank is primarily exposed to market risk, and to a lesser degree to other types of risk, such as credit risks. The aim is to completely avoid losses as a result of counterparty failure.[1]
Market risk
The market risk is the risk of Danmarks Nationalbank suffering a loss as a result of price fluctuations on the financial markets. For Danmarks Nationalbank the risk factors primarily comprise interest rates, but also exchange rates and the price of gold.
In the assessment of the risk factors' effect on Danmarks Nationalbank's financial result it is important to draw a distinction between sensitivity and risk.
Sensitivity is the extent to which a loss is incurred on a given change in a specific risk factor. The interest-rate sensitivity is expressed as the krone duration stating the loss in kroner on an increase in the level of interest rates by 1 percentage point. The foreign-exchange sensitivity can be expressed as the change in the market value in kroner on a 1-per-cent change in the exchange rate or as the market value in kroner of foreign-exchange outstandings.
On compiling the risk, the probability of loss is evaluated by combining sensitivity with the probability of a change in the risk factor concerned. The market risk is measured by Value-at-Risk, VaR, which can be interpreted as the maximum loss under normal market conditions, as well as stress scenarios focusing on losses under extremely unfavourable market conditions.
Interest-rate sensitivity and risk
Danmarks Nationalbank's assets are mainly fixed-rate bonds, while its liabilities are primarily floating-rate liabilities. Consequently, Danmarks Nationalbank will incur a capital loss in case of an interest-rate increase. At the close of 2003 this loss would amount to kr. 2.1 billion on a 1-per-cent increase in the general level of interest rates, cf. Table 9.
The bond portfolio is placed in several markets. The sensitivity to the Danish interest rates is attributable to the portfolio of Danish government, mortgage-credit and Danish Ship Finance bonds. The sensitivity to the foreign interest rates is primarily attributable to the fact that a part of the foreign-exchange reserve is placed in foreign bonds. Spreading the interest-rate sensitivity over different markets and maturity segments contributes to reducing the interest-rate risk.
Experience shows that in the long term fixed-rate bonds yield higher returns than floating-rate placements. Over an extended period, Danmarks Nationalbank is therefore expected to increase its return by assuming a certain interest-rate risk.
Foreign-exchange sensitivity and risk
Danmarks Nationalbank holds considerable foreign-exchange assets, first and foremost the foreign-exchange reserve which serves as an intervention reserve. Danmarks Nationalbank obtains an exchange-rate gain when the krone weakens since the krone value of foreign-exchange assets increases. Similarly, an exchange-rate loss is incurred when the krone strengthens. At the close of 2003 the market value of foreign-exchange outstandings totalled kr. 227 billion, cf. Table 10. Danmarks Nationalbank thus incurs a loss of kr. 2.27 billion on a strengthening of the krone by 1 per cent.
History shows that exchange-rate fluctuations from time to time can result in substantial losses. Against this background Danmarks Nationalbank has chosen to keep the currency risk at a low level. This is done by forward sale of dollars, sterling, yen and Swedish kronor against euro. The foreign-exchange sensitivity to non-euro currencies is thus transformed to euro. For example, at the end of 2003 Danmarks Nationalbank held sterling assets for kr. 11 billion, but had sold sterling forward for kr. 11 billion, cf. Table 10, thereby eliminating the sterling exposure. According to the Table Danmarks Nationalbank has chosen to retain limited dollar sensitivity to be able to intervene in dollars.
The transformation of foreign-exchange sensitivity to euro sensitivity is the key element of the management of Danmarks Nationalbank's currency risk. In a historical perspective this strategy has reduced the currency risk considerably as a result of the fixed-exchange-rate policy vis-à-vis the euro. By interacting with the interest-rate risk this strategy implies that the interest-rate sensitivity can be spread over different markets irrespective of an inherent currency risk.
Danmarks Nationalbank is exposed to the development in the gold price in view of its gold stock of kr. 5.3 billion. Gold is typically quoted in dollars and consequently contributes to the dollar sensitivity in Table 10. When the foreign-exchange sensitivity is transformed from dollars to euro the gold stock's dollar sensitivity is taken into account on equal terms with other dollar-denominated assets.
Danmarks Nationalbank does not invest actively in gold, but maintains a constant physical stock of gold. Most of the gold stock is physically placed in foreign central banks. A part of the stock is lent to banks with a high credit rating. This ensures a certain interest return in gold which is sold on an ongoing basis.
Danmarks Nationalbank's foreign-exchange outstandings increased by kr. 26 billion in 2003. The change is primarily due to the development in the foreign-exchange reserve.
Value-at-Risk
Danmarks Nationalbank's market risk is partly measured in terms of Value-at-Risk, VaR. The risk measure combines the financial positions with an estimate of the typical volatility in the market conditions. The calculation takes account of the covariation between the various risk factors.
At end-2003 Danmarks Nationalbank's VaR[2] was calculated at kr. 3.3 billion, compared to kr. 3.2 billion at end-2002, cf. Table 11. The result indicates that at end-2003, with a probability of 95 per cent – or in 19 out of 20 years – Danmarks Nationalbank will incur no loss exceeding kr. 3.3 billion. Equivalently, the result states that with a probability of 5 per cent – or in one out of 20 years – Danmarks Nationalbank will experience a capital loss exceeding kr. 3.3 billion. VaR does not indicate the size of the loss. The sum of the contributions from the each group of risk factors – interest rates, exchange rates and gold price – exceeds the total VaR. The reduction, or the diversification gain, is due to the fact that losses on all risks hardly ever appear at the same time.
The exchange-rate risk on the euro is not a traditional market risk as Danmarks Nationalbank not only has the opportunity, but also the obligation, to influence the development in the krone's rate vis-à-vis the euro. This is done solely in the interest of the fixed-exchange-rate policy and not to increase earnings. Consequently, VaR is also estimated without the exchange-rate risk on the euro, and at the close of 2003 VaR excluding the exchange-rate risk on the euro totalled kr. 3.0 billion. In general, VaR is influenced by the exchange-rate risk on the euro to a very limited extent due to the krone's stability vis-à-vis euro.
At the close of 2003 Danmarks Nationalbank's net capital totalled kr. 50.2 billion, cf. the balance sheet on p.127. VaR as a share of the net capital increased from 6 per cent in 2002 to 7 per cent in 2003.
Stress test
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 tests reflecting how extreme but realistic scenarios of market development affect the value of Danmarks Nationalbank's current portfolio are used for this purpose. It is difficult to set out realistic extreme market fluctuations. Danmarks Nationalbank has selected data from sub-periods between 1991 and 2003 in which the development in interest and exchange rates was particularly unfavourable. This data is used to set up three scenarios:
- Scenario 1: The one-year period that has given the greatest concurrent total interest and exchange-rate losses.
- Scenario 2: The one-year period that has given the greatest total interest-rate loss, combined with the one-year period that has given the greatest total exchange-rate loss. The losses 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. The losses do not have to be concurrent.
As the scenarios are set up, scenario 1 will always give the smallest loss, while scenario 3 will give the greatest loss. With the current portfolio structure, the three scenarios give a total capital loss of between kr. 12 and 18 billion, cf. Table 12. The most pessimistic scenario will give the bank a capital loss of 1/3 of its net capital.
Liquidity risk
The liquidity risk comprises several factors. For Danmarks Nationalbank, the liquidity risk is first and foremost the risk that it is not possible to release funds to support the krone, even though the funds are part of the reserve.
The principal purpose of the foreign-exchange reserve is for Danmarks Nationalbank 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 the central government's Commercial Paper programme amounting to 12 billion dollars which is managed by Danmarks Nationalbank. The programme functions as an overdraft facility in foreign currency for the central government and has been used on several occasions, e.g. in connection with the foreign-exchange crises at the start of the 1990s, when it enabled Danmarks Nationalbank to obtain large amounts within a short time. Subsequently, the programme has been used in order to maintain the central government's account with Danmarks Nationalbank at a suitable level. Furthermore, in accordance with the ERM II agreement, Danmarks Nationalbank has an opportunity to borrow at the ECB. This facility has not been used, but serves as a safety net. Danmarks Nationalbank also has access to the forward foreign-exchange market. By transacting foreign-exchange swaps where Danmarks Nationalbank receives currency and delivers kroner spot against delivering currency and receiving kroner forward, foreign exchange can be raised against collateral in kroner. However, this possibility has not been used for a number of years.
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 spreads 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 highly-rated government bonds as collateral are also used. 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 by central governments or supranational institutions with a high credit rating, or guaranteed by central governments with a high credit rating.[3] Danmarks Nationalbank thus does not hold corporate bonds or bonds issued by central governments with a low credit rating.
On placement of the domestic securities portfolio great weight is also attached to the high credit standing of the issuers. The domestic securities portfolio thus almost exclusively comprises government bonds, mortgage-credit bonds and Danish Ship Finance bonds.
The expansion of the foreign-exchange reserve during 2003 increased Danmarks Nationalbank's total credit exposure by kr. 25.4 billion to kr. 268.0 billion, cf. Table 13. A large proportion of the portfolio increase was placed with banking counterparties as collateralised deposits. Thus the credit risk is still kept at a low level.
At the close of the year 95 per cent of the foreign-exchange reserve and the domestic securities portfolio was placed in supranational institutions or in assets with a rating of Aa3 or higher. Loans in connection with monetary-policy operations, the banks' intra-day credits and cash depots are solely extended on the basis of collateralised bonds, and are not included.
Danmarks Nationalbank's accounts with notes are shown on pp. 121-134.
The accounts for 2003 have been prepared in accordance with the same accounting policies as the previous year.
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 and amounts written down was kr. 4,187 million, and thereby kr. 2,893 million lower than in 2002. The decrease reflects a decline in value adjustments, etc. of kr. 2,391 million and a fall in interest on foreign assets of kr. 749 million. After income from shares, etc. of kr. 38 million, expenses of kr. 576 million and depreciation and write-down of tangible fixed assets of kr. 40 million, the profit for the year is kr. 3,609 million, or kr. 3,055 million less than the profit in 2002.
The balance sheet increased from kr. 375.4 billion to kr. 397.3 billion.
The profit and loss account
Net income from interest
Net income from interest totalled kr. 4,454 million, which is kr. 501 million less than in 2002.
Income from interest on foreign assets fell by kr. 749 million to kr. 6,299 million. The decrease reflects lower average interest rates in 2003 compared to 2002. However, this effect is partly offset by an increase in the average foreign-exchange reserve by kr. 38.0 billion in 2003 from 2002.
Net interest to banks and mortgage-credit institutes (interest on deposits and certificates of deposit less interest on loans) was kr. 1,956 million, compared to kr. 2,288 million in 2002. The rates of interest for loans and certificates of deposit are identical, while the rate of interest for deposits has been lower than the other interest rates. The decrease in the total net interest expenditure of kr. 332 million is due to the fact that interest rates were lower than the equivalent interest rates for 2002. This was, however, partly offset by the higher average net position of the banks and mortgage-credit institutes vis-à-vis Danmarks Nationalbank, which was kr. 16.0 billion higher than in 2002.
Danmarks Nationalbank's interest expenditure on the central government's deposit decreased by kr. 191 million to kr. 1,779 million. The discount rate, which is the rate of interest on the deposit, was lower than in 2002, while the central government's balance on average was kr. 17.8 billion higher.
Interest on domestic bonds decreased by kr. 101 million to kr. 2,134 million. The decrease is due to a lower level of interest rates than in 2002 so that redemptions were reinvested at the new lower interest rate.
Value adjustments, etc.
Value adjustments resulted in a loss of kr. 267 million.
Value adjustment of Danmarks Nationalbank's gold stock gave a gain of kr. 104 million, which is related to the fact that the price of gold in dollars in 2003 increased more than the dollar rate fell.
The value adjustment of foreign-exchange positions comprises the value adjustment of the foreign-exchange reserve, as well as the value adjustment of unsettled currency transactions, currency and interest-rate swaps, domestic foreign-exchange balances, and the liability counterpart of Special Drawing Rights (SDR) allocated by the IMF. The value adjustment resulted in a loss of kr. 37 million which can be explained by a foreign-exchange gain of kr. 725 million and a market-value loss of kr. 762 million. The foreign-exchange gain generally comprised a gain in dollars and euro and a loss in SDR.
The value adjustment of domestic bonds gave a total loss of kr. 334 million.
The market-value loss on domestic and foreign bonds can primarily be related to 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 increased by kr. 71 million to kr. 576 million, or by 14.1 per cent.
Staff expenses rose by kr. 27 million to kr. 329 million, or by 9.0 per cent. Salaries and remuneration rose by kr. 1 million to kr. 245 million, other staff expenses increased by kr. 5 million to kr. 58 million and the provision carried as expenditure for support and severance schemes rose by kr. 21 million to kr. 26 million.
Other expenses totalled kr. 247 million, which is an increase by kr. 44 million or 21.7 per cent on 2002. The principal change is an increase in the expenses for major maintenance work on Danmarks Nationalbank's properties by kr. 46 million, primarily for the roof renovation of the main building.
Profit for the year
The result for the year is a profit of kr. 3,609 million, against a profit of kr. 6,664 million in 2002. Transfer of kr. 267 million from the Value Adjustment Reserve covers the negative value adjustment of the year. The Value Adjustment Reserve thus amounts to kr. 3,310 million. Kr. 775 million, or 20 per cent of the profit exclusive of value adjustments, is allocated to the General Reserves, after which the General Reserves amounts to kr. 46,635 million. Kr. 3,101 million is payable to the central government, corresponding to 80 per cent of the profit exclusive of value adjustments.
The balance sheet
Gold
The stock of gold amounted to kr. 5.3 billion at the end of the year, compared to kr. 5.2 billion in 2002. The increase is related to the increase in the price of gold calculated in kroner by 2 per cent during 2003.
Foreign assets
Assets amounted to kr. 214.4 billion at the end of the year, compared to kr. 183.0 billion in 2002, equivalent to an increase of 17 per cent. The assets are placed in euro (80 per cent), dollars (11 per cent), pounds sterling (5 per cent) and Swedish kronor (4 per cent). The positions are held mainly in highly-rated government and government-guaranteed bonds, deposits with central banks and commercial banks, or as lending against collateral in government bonds.
Foreign assets are the most significant item 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 outstanding drawing right on Danmarks Nationalbank with addition of Danmarks Nationalbank's holdings of Special Drawing Rights (SDR) in the IMF and loans for the Poverty Reduction and Growth Facility Trust (PRGF). Loans under PRGF are guaranteed by the central government. During the year, this asset decreased by kr. 0.9 billion to kr. 7.4 billion. The decrease is partly related to foreign-exchange losses of kr. 0.7 billion and partly a decrease in the item of kr. 0.2 billion as a result of the IMF's transactions.
Loans, etc.
Loans mainly comprise accounts with banks and mortgage-credit institutes and must be evaluated together with the items deposits, etc. and certificates of deposit. The net assets of the banks and mortgage-credit institutes with Danmarks Nationalbank increased from kr. 86.4 billion to kr. 119.1 billion during the year. This item includes loans related to cash depots, which decreased from kr. 3.2 billion to kr. 3.1 billion.
Domestic bonds
The value of domestic bonds decreased from kr. 41.0 billion to kr. 39.7 billion. The holdings comprise mortgage-credit bonds (kr. 19.9 billion), government bonds (kr. 16.6 billion) and bonds issued by Danish Ship Finance (kr. 3.2 billion).
Banknotes and coins in circulation
Banknotes in circulation increased by kr. 1.8 billion to kr. 45.0 billion, while coins in circulation increased by kr. 0.2 billion to kr. 4.7 billion. Banknotes in circulation include Faroese banknotes at kr. 368 million. The increase in banknotes in circulation was significantly higher than in 2002 but follows the tendency of a number of years, cf. p. 59.
Foreign liabilities
The liabilities decreased by kr. 0.3 billion to kr. 3.0 billion and comprise krone deposits with Danmarks Nationalbank from supranational institutions and other central banks.
Counterpart to Special Drawing Rights allocated by the IMF (SDR)
The allocation was unchanged during the year, and the adjustment of the item by kr. 0.1 billion to kr. 1.6 billion solely reflects the value adjustment for the year.
Deposits, etc.
Besides deposits from banks and mortgage-credit institutes of kr. 86.4 billion this item includes other deposits of kr. 4.6 billion, of which the account of Danish Ship Finance is the largest at kr. 3.4 billion.
Certificates of deposit
Certificates of deposit, which are Danmarks Nationalbank's short-term debt securities sold to banks and mortgage-credit institutes, decreased by kr. 3.4 billion to kr. 157.3 billion.
Central government
The central-government deposit decreased from kr. 50.3 billion to kr. 44.0 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. 50,245 million, which is the net capital at the beginning of the year of kr. 49,737 million less negative value adjustments of kr. 267 million and with addition of the allocation to the General Reserves of kr. 775 million.
Copenhagen, end-February 2004.
Bodil Nyboe Andersen Torben Nielsen Jens Thomsen
At the meeting of the Board of Directors held on 16 March 2004 the Board of Governors reported on the activities of Danmarks Nationalbank. The report was noted.
Danmarks Nationalbank's accounts for 2003 were submitted by the Board of Governors for adoption on the recommendation of the Committee of Directors. The Board of Directors and the Royal Bank Commissioner accepted the recommendation.
[1] Danmarks Nationalbank's financial risks and management thereof are described in more detail in the book Danmarks Nationalbank, Financial Management at Danmarks Nationalbank, 2004.
[2] 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 as of end-2003.
[3] The government-guaranteed securities include securities with an implicit government guarantee.