SPEECH
BY GOVERNOR LARS ROHDE
AT THE ANNUAL MEETING OF FINANCE
DENMARK 2019
CHECK AGAINST DELIVERY
2 December 2019
Thank you for inviting me to speak here today.
I would like to start by talking about a topic that is high on the global
agenda right now: climate change.
While there is considerable uncertainty as to what will happen, there is
little doubt by now that climate change will have major implications for
large parts of our society.
It has become clear that political actions are required in order to halt the
negative developments. A higher price for CO2, so that it reflects the
costs of carbon emissions, is the cheapest and most effective approach.
Climate change is a shared and global challenge. Consequently, stronger
international cooperation is important.
But it is also important that we all learn more about how climate change
can affect the economy and the financial sector. That is why a growing
number of central banks have begun to look at climate change in relation
to their core tasks.
Decades of inaction in relation to climate policy mean that we now have
only a limited time span to respond. And the longer we wait, the shorter
time we will have to create a green economy. Less time for transition
means greater risk for the economy and for the financial sector.
Climate change is already visible in our surroundings. We frequently see
large- and small-scale damage created by extreme weather in different
parts of the world. In Denmark we have seen e.g. droughts, gales and
flooding.
Many of you presumably remember the December hurricane in 1999. The
damage caused that evening and night amounted to around kr. 13
billion.
Flooding with extensive resultant damage may become a recurring
phenomenon in the future. One of the reasons will be rising sea levels.
Danmarks Nationalbank has calculated how the collateral behind the
credit institutions' housing loans will be affected in a scenario in which
sea levels rise considerably. In that case, the risky share of the banks'
collateral will increase notably.
These calculations are one example among many of why it may be
necessary to invest heavily in e.g. coast and climate protection if we are
to avoid the worst consequences of climate change.
It is widely agreed that the physical risks related to climate change can be
reduced if we can strengthen the transition towards a green economy at
the global level. The costs of this transition may be substantial. Especially
firms and industries that have a particularly strong carbon footprint will
be challenged. Ultimately, these challenges may rub off on the financial
sector via e.g. losses on lending and investment.
Conversely, the necessary transition will also create opportunities and a
need for new skills. So in some respects the transition towards a green
economy resembles the changes driven by globalisation.
A robust financial sector may contribute to the green transition by
ensuring continued allocation of capital. Consequently, financial
institutions should include climate-related risks in their risk management.
In the same way, central banks and authorities should include climate-
related risks in their work. A major goal should be that the requirements
for financial institutions reflect the actual risks. For example, artificial
discounts should not be given with a view to accelerating the green
transition. And conversely, capital requirements for assets
CO2-intensive
should be tightened if these prove to be linked to greater risks.
At Danmarks Nationalbank, we have begun to look at the significance of
climate change in relation to our task of ensuring a robust economy and
financial stability. Since climate change is a cross-border challenge,
solutions must also be found in cooperation with others.
That is why Danmarks Nationalbank has become a member of the
"Network for Greening the Financial System", a group of central banks
and supervisory authorities. Within this network, 48 members on a
voluntary basis exchange experience and discuss how to manage
environmental and climate-related risks in the financial sector.
Today we have also published an analysis shedding light on a number of
climate-related risks to which the financial sector is exposed. Next year
we plan to develop a stress test of the Danish banks and mortgage banks
in which focus will be on climate-related risks.
Financial Stability
Now, let me turn to the sector and its soundness. A few days ago, we
published our semi-annual analysis of financial stability in Denmark. The
good news is that the largest institutions - the systemic credit institutions
- are still posting high earnings. The systemic credit institutions achieved
a return on equity of 8.4 per cent p.a. in the first six months of this year.
If we look at how they did this, it is worth noting that profits have to a
considerable extent been boosted by factors that are unlikely to continue
in the coming years. Loan impairment charges continue to be very low.
At the same time, extensive remortgaging has had a positive impact on
the financial results.
The long period of low interest rates combined with a flat yield curve has
led to falling core earnings for the banks. Weaker earnings will reduce
the institutions' first line of defence against losses. However, I note that
several institutions have launched initiatives to safeguard future earnings,
and focus is on streamlining operations in order to reduce costs.
Well-functioning IT systems and a tight rein on costs will be key
competitive parameters for banks in the coming years. This creates an
underlying need for consolidation, also within the financial sector.
Digitalisation and new legislation give more players access to the market
for bank products. From the payments market we know that digital
solutions have a tendency to create natural monopolies because it costs
less to perform one extra transaction once the digital infrastructure is in
place.
In recent years, we have seen tech giants, such as Apple and Amazon,
enter the financial market. Experience from both the USA and China
shows that these firms are extending their original core business to
include payments and subsequently also financial services such as
lending.
Although it is difficult to predict both short- and long-term developments,
the financial sector may be seeing the emergence of new business
models in which data and network effects will play a decisive role.
As regards the banks' capitalisation, we can see that the largest
institutions meet their capital targets, but that excess capital adequacy
has shrunk in recent years. This is attributable to increasing capital
requirements, while the level of capitalisation has been stable.
We note that there is substantial variation in excess capital adequacy
across the largest institutions, and in a few institutions it constitutes less
than 2 per cent of risk-weighted exposures. This must be deemed to be a
low level of excess capital adequacy - not least because capital
requirements are expected to increase in the coming years.
In our assessment the institutions should reconsider their capital targets
so as to ensure an appropriate distance between capitalisation and
capital requirements.
The need to reconsider capital targets is underscored by the results of
our most recent stress test. It shows that a few of the systemic banks will
fall short of their capital buffer requirements in a severe stress scenario -
even if the countercyclical capital buffer is assumed to be released.
The institutions can improve their capitalisation by issuing new capital or
by disbursing a smaller share of earnings. Disbursements to shareholders
in the form of dividends and buy-backs of own shares were historically
high in 2015-2018. During that period, an average of 86 per cent of the
profit for the year was disbursed.
This year, it looks as if the level of disbursement will be considerably
lower. Lower disbursements will contribute to increasing capitalisation,
making it easier to meet higher capital targets.
The banking union
The issue of Denmark's participation in the strengthened banking
cooperation - or the banking union, as it is called - is returning to the
political agenda.
Perhaps I should start by commenting on the linguistic confusion
resulting from the term "banking union". The banking union is not a
union of banks. Nor is it a cooperation between banks, as the official
Danish name could indicate.
The banking union is cooperation at the European level between national
authorities and two European authorities on supervision and crisis
resolution of banks.
"The strengthened banking authority cooperation" would be a more
appropriate name. If only it had sounded a little more natural.
I presume you are all aware that we at Danmarks Nationalbank have
been in favour of this cooperation ever since the issue was first discussed
in 2014 and 2015. At that time we believed that it would be right for
Denmark to participate in the banking union. And we still believe that.
Why?
Basically because we believe that we should do what we can to ensure
financial stability in this country. There can be no doubt that participation
in the banking union will strengthen overall supervision of Danish credit
institutions. An extra layer will be added: an international dimension and
international competences in addition to those already existing in the
Danish Financial Supervisory Authority.
After all, the banking union is a combined mechanism. The national
supervisory authorities continue to play a key role. They do so within the
single supervisory mechanism, SSM, which supervises the very largest
institutions.
This may not sound all that attractive to you. But from a financial stability
perspective, and for Denmark as a whole, it is definitely an advantage.
Overall, we will have a stronger financial supervisory authority. We
should seize this opportunity without delay!
For you, it will also mean a more level playing field in relation to your
competitors in the euro area. Such enhanced competition will also be a
clear advantage for Danish households and firms.
Now and then concerns are expressed as to whether the single
supervisory mechanism will have sufficient understanding of the Danish
financial sector. And in this context our unique mortgage credit system is
often mentioned.
These concerns are unfounded. The SSM currently handles many different
business models in the euro area member states. And, as I have already
mentioned, the Danish Financial Supervisory Authority, which has
profound insight into the Danish system, will be a key player in the
mechanism.
The Danish Financial Supervisory Authority will continue to be deeply
involved in day-to-day supervision of all Danish credit institutions. On top
of that, Danish participation will mean that the Danish Financial
Supervisory Authority will be fully represented on the Supervisory Board
at the ECB. The Supervisory Board will make supervisory decisions
concerning institutions supervised directly by the SSM.
Decisions by the SSM must subsequently be approved by the ECB's
Governing Council. That is a formality. When the banking union was
agreed, there were no other legal options than to make the SSM part of
the ECB.
That is why the Governing Council must approve its decisions, but this
has never been intended nor proposed to mean that the Governing
Council should play an actual role in relation to supervisory decisions. So
it is of no significance to Denmark's influence that even if we participate
in the banking union we are still not represented on the Governing
Council.
Experience from the first five years of the banking union has confirmed
that supervisory decisions are considered and made by the Supervisory
Board and then formally approved by the Governing Council without
further ado.
To be on the safe side, Denmark made sure that the set of rules applying
to the banking union includes special provisions for non-euro area
member states joining the banking union. A non-euro area member state
can opt out if decisions are made that this member state does not agree
with. It is not likely that this option will be exercised. But it helps to
ensure that Denmark, as a non-euro area member state, will in fact be on
an equal footing with the euro area member states as regards terms and
conditions and rights within the banking union.
Five years ago, we believed that we ought to the banking union. Since
then our conviction has only become stronger!
Thank you.