Report on Danmarks Nationalbank's Accounts

Danmarks Nationalbank's financial risks mainly comprise market risks. The market risk is related primarily to the interest-rate and foreign-exchange sensitivity. The foreign-exchange sensitivity primarily concerns assets denominated in euro. The credit risk is very small, since Danmarks Nationalbank exclusively holds claims on counterparties with a high credit standing, and to a significant extent requires the pledging of collateral. During 2002 Danmarks Nationalbank's market risk, measured by Value-at-Risk (VaR), decreased from kr. 5.9 billion to kr. 3.2 billion. The decrease is due to a reduction of the bank's sensitivity to changes in interest rates combined with lower volatility in the financial markets.

Danmarks Nationalbank's accounts for 2002 show a profit of kr. 6.7 billion, compared to kr. 4.8 billion in 2001. This adjustment is due mainly to the increase in value adjustments, etc. by kr. 2.0 billion to kr. 2.1 billion. Of the profit for the year, kr. 2.1 billion is allocated to the Value Adjustment Reserve, and kr. 0.9 billion to the General Reserves. The remainder of kr. 3.6 billion is payable to the central government.

Danmarks Nationalbank's financial assets and liabilities entail that it is exposed to a number of financial risks that can affect the financial result. The principal assets are foreign deposits and securities, domestic bonds and loans to Danish banks. The principal liabilities are banknotes and coins in circulation, deposits and certificates of deposit, and the deposits of the central government, cf. the balance sheet on pp. 126f. Danmarks Nationalbank is primarily exposed to market risks, and to a lesser degree to other types of risk, e.g. credit risks.

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

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

On compiling the risk, the probability of loss is evaluated by combining sensitivity with the probability of a change in the risk factor concerned. For example, Value-at-Risk (VaR) is used to compile the total market risk. VaR indicates the loss that is only exceeded in rare cases.

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

On the basis of the generally low level of interest rates Danmarks Nationalbank's sensitivity to changes in interest rates was reduced in 2002.

In 2002, Danmarks Nationalbank divested the portfolio of Japanese bonds. Instead, a portfolio of Swedish bonds was built up. The divestment of Japanese bonds should be viewed against the very low level of interest rates in Japan, as well as rating agencies' downgrading of the Japanese central government.

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

The exchange-rate risk on the foreign-exchange-denominated assets is limited by forward sale of dollars, sterling, yen and Swedish kronor against euro. This reduces the exchange-rate risk on Danmarks Nationalbank's bond and money-market placements in those currencies. For example, at the close of 2002 Danmarks Nationalbank held sterling assets for kr. 11 billion, but had sold sterling forward for kr. 11 billion, cf. Table 10. The total net sterling outstanding thereby amounted to zero in net terms. The exchange-rate risk cannot be eliminated completely by selling currency forward against kroner, since this will affect the krone rate. Danmarks Nationalbank's sensitivity to changes in exchange rates therefore almost entirely concerns the euro. A change in the krone's rate against the dollar, pound sterling, yen and Swedish krona has only a modest effect on Danmarks Nationalbank's result.

In view of its gold stock of kr. 5.2 billion Danmarks Nationalbank is exposed to the development in the gold price. Danmarks Nationalbank does not actively invest in gold, but maintains a constant physical stock of gold. Part of Danmarks Nationalbank's gold stock is placed in banks with a high credit rating. This ensures a certain interest return. In 2002, part of the stock of gold coins and obsolete gold bars was resmelted into standardised gold bars that can be used for lending. Gold is typically quoted in dollars, and therefore contributes to the dollar exposure in Table 10.

Value-at-Risk
Danmarks Nationalbank uses various measures to evaluate the market risk. One of these is Value-at-Risk (VaR), which combines the financial positions with an estimate of the typical fluctuation in market conditions. The calculation takes account of the covariation between the various risk factors, which for Danmarks Nationalbank are interest rates, exchange rates and the gold price. VaR is supplemented with stress scenarios to calculate the impact of extreme fluctuation in the risk factors on Danmarks Nationalbank's portfolio.

At end-2002, Danmarks Nationalbank's VaR was calculated at kr. 3.2 billion one year forward^[1], cf. Table 11. The figure indicates that, with a probability of 5 per cent, or in one out of 20 years, Danmarks Nationalbank will suffera capital loss exceeding kr. 3.2 billion. At the close of 2001, VaR was kr. 5.9 billion. The decrease in VaR is related to the lower sensitivity to changes in interest rates, cf. above, and a lower volatility in the financial markets in the 2nd half of 2002 compared to one year before.

The exchange-rate risk on the euro is not a traditional market risk, since Danmarks Nationalbank not only may, but is also obliged, to influence the krone/euro rate. Moreover, Danmarks Nationalbank will only sustain a loss if the krone strengthens against the euro. Therefore VaR excluding the exchange-rate risk related to the euro is also calculated. VaR excluding the euro-related exchange-rate risk was kr. 3.3 billion at the end of 2002. Elimination of the exchange-rate risk related to the euro thus entails a marginally higher risk. In other words, the euro-realated exchange-rate risk reduced Danmarks Nationalbank's overall risk as of the end of 2002. The reason is that the basis for calculation included a positive covariation between the long-term interest rates and the exchange rate for the krone vis-à-vis the euro. This meant that market-value losses were partly set off by euro-exchange-rate gains, and vice versa. This is not always the case. At the end of 2001, the euro-related exchange-rate risk thus contributed to a higher VaR.

Danmarks Nationalbank's net capital totalled kr. 50 billion at the close of 2002, cf. the balance sheet on p. 127. VaR as a ratio of net capital fell from 13 per cent in 2001 to 6 per cent in 2002.

As the scenarios are set up, scenario 1 will always give the smallest loss, while scenario 3 will give the greatest loss. In view of the current portfolio structure, the three scenarios give a total capital loss of between kr. 11 and 16 billion, cf. Table 12. The most pessimistic scenario will give the bank a capital loss of 1/3 of net capital.

Liquidity risk
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. Finally, in accordance with the ERM II agreement, Danmarks Nationalbank has an opportunity to borrow at the ECB. This facility has not been used, however.

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

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

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

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

For deposits with foreign banks repo agreements with government bonds as collateral are 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^[2]. 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 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 2002 increased Danmarks Nationalbank's total credit exposure by kr. 44 billion to kr. 243 billion, cf. Table 13. A large proportion of the portfolio increase was placed with banking counterparties. The greater credit exposure and general downward adjustment of the credit standing^[3] of international banks led to an increase in Danmarks Nationalbank's credit risk in 2002. However, the credit risk is still kept at a low level. At the close of the year95per cent of the foreign-exchange reserve and the domestic securities portfolio was thus placed in supranational institutions or in assets with a rating of Aa3 or higher, cf. Table 13.

Danmarks Nationalbank's accounts with notes are shown on pp. 121-133.

The accounts for 2002 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 was kr. 7,079 million, and thereby kr. 1,476 million higher than in 2001. The increase primarily reflects positive value adjustments, etc. of kr. 2,000 million to kr. 2,124 million from kr. 124 million in 2001. After income from shares, etc. of kr. 23 million, other income from ordinary operations of kr. 101 million, expenses of kr. 505 million and depreciation and amortisation of tangible fixed assets of kr. 34 million, the profit for the year is kr. 6,664 million, or kr. 1,870 million more than the profit of kr. 4,794 million in 2001.

The balance sheet increased from kr. 295.3 billion to kr. 375.4 billion. The increase in liabilities is primarily related to certificates of deposit and deposits from banks and mortgage-credit institutes as a consequence of an increase in the foreign-exchange reserve.

The profit and loss account
Net income from interest
Net income from interest totalled kr. 4,955 million, which is kr. 523 million less than in 2001.

Income from interest on foreign assets rose by kr. 595 million to kr. 7,048 million. The increase is a consequence of an increase in the average foreign-exchange reserve by kr. 56.8 billion in 2002 from 2001, which is, however, partly set off by average lower interest rates in 2002.

Net interest to banks and mortgage-credit institutes (interest on deposits and certificates of deposit less interest on lending) was kr. 2,288 million, compared to kr. 1,186 million in 2001. The rates of interest for certificates of deposit and lending are identical, while the rate of interest for deposits is lower. The increase in the total net interest expenditure of kr. 1,101 million is related to the higher average net position of the banks and mortgage-credit institutes vis-à-vis Danmarks Nationalbank in 2002 than in 2001, which was, however, partly set off by lower interest rates than the equivalent interest rates for 2001.

Danmarks Nationalbank's interest expenditure on the central government's deposit decreased by kr. 239 million to kr. 1,970 million. The discount rate, which is the rate of interest on the deposit, was lower, while the central government's balance on average was higher than in the preceding year.

Interest on loans to other borrowers fell by 75 million to kr. 105 million. The change is predominantly related to currency swaps with Danish Ship Finance that entailed a decrease by kr. 69 million, primarily because interest received was settled at a lower dollar exchange rate than in 2001.

Interest to other depositors, etc., was halved from kr. 267 million in 2001 to kr. 135 million, primarily because Danmarks Nationalbank's obligations to Danish Ship Finance^[4] on average were significantly lower than in the preceding year.

Interest on domestic bonds fell by kr. 333 million to kr. 2,235 million. The decrease is due to a smaller portfolio on average and a lower level of interest rates than in 2001.

Value adjustment of Danmarks Nationalbank's gold stock gave a gain of kr. 219 million, which is related to the fact that the price of gold in dollars increased more than the dollar rate fell in 2002.

The value adjustment of foreign-exchange positions comprises the value adjustment of the foreign-exchange reserve, as well as the value adjustment of unsettled foreign-exchange contracts, currency and interest-rate swaps, domestic foreign-exchange balances, and the liability counterpart of Special Drawing Rights (SDR) allocated by the IMF. The upward value adjustment of kr. 1,126 million can be attributed to a foreign-exchange gain of kr. 212 million and a market-value gain of kr. 913 million. The foreign-exchange gain generally comprised a gain in dollars and a loss in euro and SDR.

The value adjustment of domestic bonds gave a total gain of kr. 791 million.

The market-value gain on domestic and foreign bonds can be related to the general decrease in international interest rates, which is partly set off by the fact that a large proportion of the bond portfolio at the beginning of the year had a market value above par, and therefore automatically released a capital loss in step with redemption, or because the redemption date was forthcoming. This capital loss is estimated at approximately kr. 1 billion.

Write-downs on financial fixed assets comprise a write-down of kr. 12 million on the bank's shares in Det Danske Stålvalseværk to kr. 0, since this company is subject to compulsory winding-up.

Expenses
Total expenses decreased by kr. 9 million to kr. 505 million, or by 1.7 per cent.

Staff expenses rose by kr. 1 million to kr. 302 million. This increase reflects an increase in salaries and remuneration by kr. 12 million to kr. 243 million, or 5.3 per cent. Other staff expenses fell by kr. 6 million to kr. 54 million, and the provision carried as expenditure for support and severance schemes decreased by kr. 5 million to kr. 5 million.

Other expenses constitute kr. 203 million, which is a decrease by 10 million, or 4.6 per cent, on 2001. The principal changes are described briefly below. Materials for production of banknotes increased by kr. 10 million to kr. 25 million as a consequence of an increase in note production, while materials for minting of coins fell by kr. 5 million to kr. 11 million, due to a decrease in coin production. Operation of the bank's properties fell by kr. 12 million to kr. 62 million as a consequence of the decrease in major maintenance projects. Data processing, etc. fell by kr. 10 million to kr. 33 million, mainly due to falling prices. Minor acquisitions and maintenance of machines and equipment increased by kr. 9 million to kr. 20 million, mainly attributable to IT development projects. Finally, kr. 4 million is carried as income concerning reimbursement of VAT on canteen services paid in previous years.

Profit for the year and allocation of profit
The result for the year is a profit of kr. 6,664 million, against a profit of kr. 4,794 million in 2001. 

For the years 1995-2001, the following principle is applied to the annual decisions on allocation of profits: positive value adjustments are allocated to the Value Adjustment Reserve. Negative value adjustments are covered from the Value Adjustment Reserve as far as possible. After transfer to/from the Value Adjustment Reserve 30 per cent of the available amount is allocated to the General Reserves for consolidation of Danmarks Nationalbank. The remaining 70 per cent of this amount is payable to the central government in accordance with the Danmarks Nationalbank Act.

At the close of 2001 Danmarks Nationalbank's General Reserves amounted to kr. 45.0 billion. Allocations to the General reserves in 1995-2001 entailed an average annual increase in net capital of 3½-4 per cent, i.e. a stronger rate than the development in prices, but weaker than the development in nominal GDP.

It is important that there is indisputable confidence in a central bank's solvency, and that the central bank's own economic position does not affect the monetary and foreign-exchange policy. The net capital should therefore be substantial in view of the central bank's balance sheet and activities, and there should be a degree of ongoing consolidation. In view of the current size of the net capital a reasonable guideline would be for the level of consolidation to generally adhere to the development in prices, i.e. that Danmarks Nationalbank's General Reserves are maintained at a constant real level. It has therefore been decided to reduce the proportion of the profit that is allocated to the General Reserves to 20 per cent.

On the establishment of the Value Adjustment Reserve the objective was to ensure a more stable annual transfer to the central government. This target has been reached, since every year since 1995 more than kr. 3 billion has been transferred. At the end of 2001, the Value Adjustment Reserve was kr. 1.5 billion, and capital gains of kr. 2.1 billion in 2002 increase the reserve to kr. 3.6 billion.

However, there is a risk that the profit transfer in one of the coming years will be lower than the level of around kr. 3 billion seen in preceding years. The current sensitivity to changes in interest rates of kr. 2.2 billion, cf. p. 108, and ongoing capital losses as a consequence of the reduction of remaining maturity, cf. p. 116, mean that, all other things being equal, a general increase in interest rates by 1 per cent will lead to a total capital loss exceeding kr. 3 billion. If the capital loss is greater than the Value Adjustment Reserve, the amount for distribution between the General Reserves and the central government must be reduced by the proportion of the capital loss that cannot be covered from the Value Adjustment Reserve.  

To summarise, the profit for the year is allocated as follows:

• An amount equivalent to the value adjustments for the year – kr. 2,124 million – is allocated to the Value Adjustment Reserve, which hereafter amounts to kr. 3,577 million.
• 20 per cent of the profit after allocation to the Value Adjustment Reserve – kr. 908 million – is allocated to the General Reserves, which hereafter amount to kr. 45,859 million.
• The remaining amount of 80 per cent of the profit after allocation to the Value Adjustment Reserve – kr. 3,632 million – is transferred to the central government.
  
  

The balance sheet
Gold
The stock of gold amounted to kr. 5.2 billion at the end of the year, compared to kr. 5.0 billion in 2001. The increase is related to the increase in the price of gold calculated in kroner by 4 per cent during 2002.

Foreign assets
Assets amounted to kr. 183.0 billion at the end of the year, compared to kr. 138.6 billion in 2001, equivalent to an increase of 32 per cent. The assets are placed in euro (78 per cent), dollars (12 per cent), pounds sterling (6 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 rights 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. During the year, this asset increased by SDR 47.6 million, equivalent to kr. 0.4 billion. In Danish kroner the item fell by kr. 0.3 billion to kr. 8.3 billion. The decrease is related to foreign-exchange losses of kr. 0.7 billion, partly counterbalanced by the aforementioned increase in the asset as a consequence of drawing by the IMF.

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. 51.8 billion to kr. 86.4 billion during the year. This item includes loans related to cash depots, which increased from kr. 2.1 billion to kr. 3.2 billion.

Domestic bonds
The holdings are unchanged at kr. 41.0 billion and almost exclusively comprise mortgage-credit bonds (kr. 20.1 billion), government bonds (kr. 17.8 billion) and bonds issued by Danish Ship Finance (kr. 3.1 billion).

Banknotes and coins in circulation
Banknotes in circulation increased by kr. 0.2 billion to kr. 43.2 billion, while coins in circulation increased by kr. 0.2 billion to kr. 4.5 billion. Banknotes in circulation include Faroese banknotes at kr. 382 million. The increase in banknotes in circulation was significantly lower than in recent years, cf. p. 59.

Foreign liabilities
The liabilities decreased by kr. 0.4 billion to kr. 3.3 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. 0.2 billion to kr. 1.7 billion solely reflects the value adjustment for the year.

Deposits, etc.
Besides deposits from banks and mortgage-credit institutes of kr. 56.6 billion this item includes other deposits of kr. 5.1 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, increased by kr. 47.0 billion to kr. 160.7 billion.

Central government
The central-government deposit increased from kr. 43.5 billion to kr. 50.3 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. 49,737 million, which is the net capital at the beginning of the year of kr. 46,705 million with addition of the allocation to the Value Adjustment Reserve of kr. 2,124 million, as well as the allocation to the General Reserves of kr. 908 million.

Danmarks Nationalbank's accounts for 2002 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.