Interview: Kristian Vie Madsen, Danish FSA

Nov 8th, 2012

Danish FSA Deputy Director General Kristian Vie Madsen spoke to The Covered Bond Report’s Neil Day about the failure of Tønder Bank and the state of the Danish banking industry.

What is DFSA doing to avoid situations like that of Tønder Bank recurring?

Kristian Vie MadsenThe Danish FSA is probably one of the most hands-on supervisory authorities in Europe, especially when it comes to our inspection activities. We have a high frequency of on-site inspections in risky banks, and the loan books of banks on intensified supervision are inspected every year. Our staff go through individual credit files on-site, and we normally evaluate 30%-60% of the loan book individually.

From our perspective, Tønder Bank was an outlier case in the sense that the other banks that have failed in Denmark during the financial crisis all in advance had shown warning signals in the shape of e.g. high exposure to risky loan segments such as commercial real estate or agriculture, high lending growth or many large exposures. Tønder Bank showed none of these characteristics. Instead, the failure has shown a case of misconduct, as the bank failed to comply with the rules for write-down of loan losses and the accountant apparently didn’t react to this. We are currently evaluating the possibilities for legal steps in order to hold the management, the board of directors and the accountant responsible for the events in Tønder Bank.

To sum up, our general perception of the risks in the Danish banking sector hasn’t changed because of this unfortunate event. We consider the banking sector quite robust, especially when it comes to the large Danish banks. The group of banks with potential solvency problems in the next year and a half is small and accounts for no more than approximately 3% of the Danish banking sector measured by share of loans.

What effect have the new impairment rules had on Danish banks in 2012?

The new impairment rules were introduced with effect from the second quarter of 2012. The main change concerns impairments on commercial property loans where the impairment calculations must be based on the market value of the property. This implies greater transparency on impairments, which is beneficial for both banks and their creditors and investors.

As regards the numbers, banks’ total impairments increased from about DKK6bn in Q1 to about DKK7.5bn in Q2. This is — we think — a quite modest increase and reflects that a large number of banks were already applying procedures similar to the new rules.

However, a smaller number of banks experienced more significant increases in their impairments. But this is a natural consequence when you narrow the limits of management discretion as we have done with the new rules. And hopefully it will imply that banks’ own impairment calculations will be more in line with the FSA’s when we go on inspections in individual banks.

What are the benefits of the new method for credit institutions’ solvency requirements?

The new approach to solvency requirements consists of two elements: a new recommended method for calculating the individual solvency requirement (the so-called 8+ method); and a new (and more patient) approach towards banks who fall below their individual solvency requirement.

The rationale for the new 8+ method is that it will give solvency requirements that better reflect actual risks in individual banks. This is primarily because the 8+ method is more focused on the risks associated with large loans to weak costumers, which is a key risk behind many of the bank failures that we have seen during the crisis.

The more patient approach to challenged banks is the result of new legislation that will be put before Parliament later this month. It implies that banks who fall below their solvency requirements (but still have a solvency ratio above 8%) will have more time to restore their capital base compared to the present framework where banks are closed if they do not meet their individual solvency requirement — even if they are above the minimum 8% threshold.

In practice a bank that falls below its capital requirement will be met with a number of sanctions and requirements including an obligation to submit a capital restoration plan to the FSA. If the requirements are not met or there is insufficient progress on capital restoration, the FSA will retain the power to close the bank even with a solvency ratio above 8%.

Taken together, we think the two elements constitute a well balanced approach under the present circumstances: risky banks will have to put aside more capital, but challenged banks will have more time to find solutions, thereby hopefully reducing the number of bank failures going forward.

What progress are Danish banks making in strengthening their capital?

Since the beginning of the crisis we have seen significant increases in sector total capital ratios — both measured in terms of total capital and in terms of Core Tier 1. The total capital ratio of banks has increased from about 14% at the end of 2008 to just short of 20% after the first half of 2012. Similarly the Core Tier 1 ratio has increased from about 10% to 14.6% in the same period.

We expect this development to continue not least in light of the general demand from capital markets that banks should be better capitalised both in size and quality.

Is DFSA satisfied with the funding profiles of Danish banks and their market access?

The funding situation has improved considerably due to the reduced deposit deficit. The small and medium-sized banks have — taken together — closed the funding gap by balancing loans and deposits. Meanwhile the bigger banks continue to have access to the international funding markets.

Some of the smaller and medium-sized banks still have challenges going forward when the individual state guarantees expire in 2012 and 2013. But we are following these banks closely and we see good progress in addressing the challenges.

Photo: Henrik Clifford

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