What is a stable financial system?

Ensuring that the financial sector is stable enough to weather crises is essential for the Danish economy. One of Danmarks Nationalbank’s most important tasks is to contribute to the stability of the financial system. We do this by keeping an eye on threats to financial stability in order to intervene at an early stage and prevent problems from becoming systemic.

What is financial stability?

Financial stability means that the financial sector is robust enough to withstand economic or financial crises. Even during a crisis, the financial sector must be robust enough for customers to continue to make and receive payments and to borrow money for sound and creditworthy projects.

Why is it important to ensure financial stability?

Banking crises can affect the whole economy. If a bank incurs very large losses because some of its customers cannot repay their loans, the bank may become more reluctant to grant new loans or stop lending altogether. If this happens to many banks at the same time, the worst-case scenario is that households and companies will find it difficult to obtain loans – even if their finances are healthy.

If households and companies are unable to obtain loans, they will not be able to purchase a house or invest, for instance. Should that happen for many households and companies at the same time, it might mean that consumption and investments decrease. This could have serious costs to the economy and society.

Some banks are so large and complex that the entire financial sector and economy could be impacted if they come under pressure. These banks are called systemically important institutions – or SIIs. In Denmark, the Danish Financial Supervisory Authority designates SIIs. SIIs are closely monitored, and special requirements are imposed on them.

A precondition for stability in the financial sector is that the individual credit institutions are robust, including that they have sufficient capital and liquidity reserves to draw on in difficult times. Even if an individual bank appears robust, there may still be risks in the financial system as a whole that could lead to a financial crisis. Indeed, financial crises are often the result of imbalances building up over a long period of time in the interaction between the financial sector, companies, households and investors.

How does Danmarks Nationalbank promote financial stability?

Danmarks Nationalbank oversees the financial system to identify problems, enabling it to intervene at an early stage.

In its activities regarding financial stability, Danmarks Nationalbank focuses on the financial system as a whole and on the largest banks, described as systemically important. The Danish Financial Supervisory Authority ensures that individual banks meet the requirements under financial regulation – this is not a task for Danmarks Nationalbank

Danmarks Nationalbank assesses, among other things, whether trends in financial markets, lending, earnings or the institutions’ capital or liquidity management may lead to vulnerabilities in the financial system. This is done, for instance, in Danmarks Nationalbank’s semi-annual analysis of financial stability in Denmark. Danmarks Nationalbank also expresses its views through  public consultations and speeches.

The tools employed to mitigate systemic risks and reduce the risk of new financial crises are called macroprudential measures. In Denmark, the Systemic Risk Council can make recommendations on specific macroprudential measures to limit the risk of new financial crises. Danmarks Nationalbank is the secretariat for the Systemic Risk Council.

Danmarks Nationalbank also promotes financial stability by working closely with authorities and the financial sector. If financial stability is under pressure, the goal is to minimise the negative consequences, without costs to society. It is therefore important that relevant authorities and the institutions themselves are prepared to deal with a crisis.

International cooperation is essential, given that the Danish economy and the financial sector are interconnected with other countries. Danmarks Nationalbank participates in international fora aimed at promoting financial stability.