Financial stability 1st Half 2016

Authors Danmarks Nationalbank
Subject Financial stability
Type Financial Stability
Year 2016
Published 24 June 2016
Abstract icon In 2015, the systemic credit institutions achieved the highest profit since the financial crisis. The rise in earnings was boosted by a strong decline in impairment charges on loans and guarantees relative to the preceding year. A number of institutions target an annual return of up to 12.5 per cent after tax on their book value of equity. Credit institutions should carefully consider whether their current targeted returns are fully consistent with a prudent level of risk.

In 2015, the systemic credit institutions achieved the highest profit since the financial crisis. The rise in earnings was boosted by a strong decline in impairment charges on loans and guarantees relative to the preceding year. Credit institutions’ net interest income is under pressure from low demand for new loans and a low interest rate level with negative monetary policy interest rates. Conversely, fee income and administration margins account for increasing proportions of credit institutions’ income and make up for the decline in net interest income.

A number of institutions target an annual return of up to 12.5 per cent after tax on their book value of equity. Credit institutions’ targeted re-turns exceed the return on book value of equity currently required for shareholders to be ready to invest in bank shares. One way for the institutions to achieve a high ROE is to increase their risk. This can be done via more risky lending or by reducing equity relative to exposures. Credit institutions should carefully consider whether their current targeted re-turns are fully consistent with a prudent level of risk.

With a view to strengthening the framework for risk-weighted capital requirements, the Basel Committee has presented various proposals. These measures comprise a proposal for a capital floor. The Basel Committee’s proposed measures may give credit institutions inexpedient incentives, because they may enable the institutions to increase their risk without increasing their capitalisation, if the measures are binding. It is in the interest of Denmark to have a level playing field for credit institutions across national borders. But it is essential that the final design of the cap-ital floor is sufficiently differentiated in order to allow for fundamental factors related to credit risk, e.g. differences in the rules on liability and default in the individual countries.