SPEECH
SPEECH BY GOVERNOR LARS ROHDE AT THE
ANNUAL MEETING OF FINANCE DENMARK 2017
CHECK AGAINST DELIVERY
4 December 2017
Thank you for inviting me to speak here today.
I will be delivering three key messages:

Optimism and large lending capacity are boosting the banks' risk
appetite.

Danmarks Nationalbank is not planning to issue central bank digital
currency to the public.

And last but not least: the risky ties between the government and the
financial sector should be broken.
Slide 2: Full steam ahead for the financial sector
First, I would like to talk about developments in the financial sector. We
have put the financial crisis behind us. The sector is now better capital-
ised than before the crisis. Danmarks Nationalbank's most recent stress
test shows that all SIFIs are able to meet the minimum capital require-
ments in a severe recession.
There is a sentiment of optimism in the financial sector, both in Denmark
and abroad. The banks and their customers have regained their risk
appetite and at the same time there is plenty of liquidity in the global
financial markets.
In other words - there is a basis for a general increase in risk-taking. And
indeed, we are seeing signs of this.
Fortunately, the economy is picking up steam again. That is clearly visible
from the bottom lines of the banks and mortgage banks.
These institutions now have considerable capacity to increase lending,
and many have stated that they are easing their credit standards.
Lending fluctuates with the business cycle, so it is only natural that
lending grows in an economic upswing.
In some respects, current developments are similar to the period leading
up to the financial crisis in 2008. But there is one major difference, and
that relates to credit growth, which is still well below the strong level
seen in the pre-crisis period.
All the same, it is worth noting that total lending remains at a very high
level and that it did not fall at any time in the years of economic
downturn.
Slide 3: Financial risks
If we zoom in on the trend in lending, there are signs of risks building up.
Banks and mortgage banks are increasing lending to vulnerable
households with high debt ratios and the medium-sized banks have increased
lending to cyclical industries.
So no, credit growth is not soaring at the moment. But yes, risks are
building up. The level of interest rates is low and risk appetite is high.
Combined with the economic upswing, rising asset prices and potentially
strong credit growth, this is a toxic cocktail that could cause a hangover
if we are not careful.
That is why Danmarks Nationalbank assesses that the conditions for
activating the countercyclical capital buffer are in place.
The purpose of this buffer is to reduce the economic downturn in the
event that households' and firms' access to credit is tightened
disproportionally in periods of stress in the financial system. When the buffer is
released, the institutions gain access to capital which they can use to keep
up their lending capacity.
To increase the probability that the buffer has been built up before a
period of financial stress occurs, it must be built up in good times like the
present - while it is easy to do so.
The Systemic Risk Council can submit a recommendation to change the
buffer rate to the Minister for Industry, Business and Financial Affairs. At
its December meeting, the Council will consider whether to activate the
buffer.
***
Exactly one year ago, we launched the shared vision that the Danish
financial sector is to be "best in class" in Europe in terms of combating
cybercrime.
That work is now well underway, and I would like to express my
appreciation of the good cooperation we have had the first year. A couple of
weeks ago, Danmarks Nationalbank held the first Nordic cyber
conference in Copenhagen. There was widespread agreement that Denmark is
among the most digitised countries, but also that Denmark may not be in
the top league when it comes to the degree of cybersecurity.
We must continue our journey towards increased cybersecurity. So in
2018 Danmarks Nationalbank will conduct a survey similar to that carried
out in 2016 to see whether cyber resilience has increased, and we will
also establish an "intelligence-led red-team testing programme" for the
financial sector. I think this programme will be useful for the individual
actors and for the sector overall. I also see it as a necessary step towards
realising our vision of being best in class.
Slide 4: CBDC
Denmark is one of the most digitised countries in the world. Does that
mean that we should also have central bank digital currency as a
supplement to cash and deposits in commercial banks?
In the near future we will publish an analysis of this topic, but I can
already today disclose some of the conclusions. The short answer is no,
Danmarks Nationalbank should not offer retail banking services to all
Danes.
An important thing to keep in mind when discussing central bank digital
currency is that it has very little to do with the so-called crypto
currencies, of which bitcoin is probably the best known one.
Whereas central bank digital currency would represent a claim on
Danmarks Nationalbank - like cash - a crypto currency does not represent a
claim on anybody, so it has no underlying value. Another significant
difference is that money issued by Danmarks Nationalbank is stable in value.
In contrast, the value of crypto currencies can fluctuate strongly, which
makes them very poorly suited as means of payment or stores of value.
One argument used in favour of central bank digital currency is that it
promotes a more secure and efficient payment system. In my opinion,
that argument is not particularly relevant in a Danish context. In Denmark
we already have a secure and efficient payment system in which
payments are settled fast, smoothly and securely. It is possible to transfer
funds from an account to any other account, and instant payments allow
funds to be transferred in seconds.
Another argument used is that households and firms should be entitled to
a secure asset. I can only say that it is already possible today to invest
assets securely by holding cash, buying Danish government bonds or
making deposits in commercial banks up to the guaranteed limit of
approximately kr. 750,000. Full coverage of larger deposits can be obtained
by spreading deposits on several banks so that the limit of kr. 750,000 is
not exceeded in any one bank.
A third argument is to establish a back-up system that can take over if the
current payments infrastructure is disrupted. Establishing a payment
system that is completely independent of the existing system would require
considerable resources. And a new system would still be subject to some
of the same dependencies as the current system, such as the electricity
grid. In my view, it makes more sense to spend that money on enhancing
the robustness of the existing systems, e.g. in relation to cyber risks.
I acknowledge that the above arguments may be valid in other countries
where e.g. the payment systems are more fragmented. But in a Danish
context I find it difficult to see what central bank digital currency would
contribute with that our existing payment solutions do not already offer.
We already have digital money in the form of bank deposits.
In our assessment, the potential gains from introducing central bank
digital currency do not match the considerable challenges that its
introduction might create.
If Danmarks Nationalbank were to issue central bank digital currency, our
role in the financial system would change. Danmarks Nationalbank would
go from being banker to the banks to being banker to the general public.
In that way we would be competing directly with the commercial banks,
e.g. by offering deposit accounts and payment services, a role not
traditionally assumed by central banks.
The introduction of central bank digital currency would also create a risk
of financial instability by increasing the risk of systemic bank runs. Today
it is difficult to carry out a run on the Danish banking system overall
unless deposits are moved to abroad. But in practice it is not possible to
exchange all bank deposits for cash. But with central bank digital curren-
cy, bank runs can take place rapidly and become systemic. In periods of
loss of confidence in the Danish banking sector, this is possible despite
the deposit guarantee scheme and any higher interest on bank deposits.
So I can set your minds at ease: Danmarks Nationalbank has no plans to
compete directly with the banks. As you know, Danmarks Nationalbank's
objectives are to contribute to ensuring financial stability, stable prices
and safe payments.
***
I will now turn to the issue of how to resolve large banks and mortgage
banks in a crisis situation.
A precondition for preparing credible resolution plans for the largest
Danish financial institutions - the SIFIs - is that a group can be resolved
as a single corporation.
The resolution authorities should apply a single point of entry resolution
strategy aimed at recapitalising and continuing the whole group. This is
because the SIFIs are deeply integrated, both commercially and
operationally.
Since the plan is to recapitalise the whole group, own funds and eligible
liabilities must, of course, be issued for recapitalisation of all parts of the
group. To ensure the necessary credibility of the resolution plans, the
minimum requirement for own funds and eligible liabilities, MREL, must
observe three principles.
Slide 5: 3 Key principles
Firstly, the MREL must reflect the current risks of the specific SIFI. The
requirement cannot be capped as is the case for the current debt buffer.
For high-risk institutions, a cap on the MREL would mean insufficient
liabilities eligible for writing-down and hence for covering the losses that
may occur. For currently low-risk institutions, the requirement will be too
low if the risks increase. As a result, the MREL will be too low precisely at
the time when own funds and eligible liabilities are required for
absorbing losses. That may have implications for financial stability and for the
government finances.
It is a sound principle that the requirements for financial institutions are
risk-based. I suppose we all agree on that. This helps to ensure sound
incentives. So the Basel output floors that remove sensitivity to risk is not
an idea that we have nurtured. The MREL should be risk-based like the
capital requirements.
Secondly, the MREL should be the same, no matter how risk is distributed
across the group. This means that there is no incentive to move risks to
the entity subject to the least stringent requirements.
Thirdly, the MREL should be neutral from a competition perspective. The
MREL to cover loans of the same nature which are to be treated equally
in a resolution solution must be the same, irrespective of whether the
loan has been granted by a bank or a mortgage bank.
If these principles are to be observed, a consolidated MREL must be set,
comprising all entities of a SIFI. This will also bring us in line with
European standards.
We suggest that the MREL is, as a main rule, set at twice the capital re-
quirement plus the combined buffer requirement for all SIFIs. We also
suggest that a reduction is granted for, inter alia, the Basel floors if they
are introduced so that the requirement does not become unreasonably
severe in relation to the actual risks of the groups.
However, 8 per cent of the total balance sheet assets is a relevant
minimum requirement so that it is possible to top up with funds from the
Resolution Fund if necessary.
Legislation says that mortgage banks must be resolved without use of
bail-in. That is why mortgage banks are exempt from the MREL. Since this
legislation was adopted, we have been putting much effort into finding
out how to resolve SIFIs.
Slid 6: It was a mistake
We made a mistake when we exempted mortgage banks from bail-in and
MREL and introduced the debt buffer. The work on SIFI resolution plans
has now reached a point where it is necessary for us to correct this error
so that we can proceed.
Consequently, Danmarks Nationalbank has recommended that the
legislator should repeal the exemption of mortgage banks from bail-in and
MREL. The potential gains are large, while the costs are very limited.
This will make it possible to adapt resolution plans to the SIFIs' business
models and not vice versa.
The alternative - to operate with plans to discontinue mortgage banks by
winding them up -is not credible. The mortgage banks are closely
interwoven with the rest of the financial system due to the role of mortgage
bonds in liquidity management. So the discontinuation of a mortgage
bank would have a knock-on effect on the rest of the financial system. At
the same time, the sector concentration is so high that much of its
lending capacity would vanish if any one institution ceases to exist.
If an acceptable resolution scheme for failing SIFIs is not put into place,
everyone will expect the government to save them. Mortgage banks
operate under an implied government guarantee as long as they are
exempt from bail-in and MREL.
When owners and creditors believe that an institution will be saved by
the government, they will assume greater risks than otherwise. After all,
the taxpayers will foot the bill if things go wrong. The absence of credible
resolution plans for SIFI groups and mortgage banks distorts incentives
and competition within the sector.
Indeed, the Competition Council's conclusion is that credible resolution
plans must be prepared for the large mortgage banks and that they must
be supported by MREL or perhaps by additional capital.
If the exemption is repealed, this will increase competition to the benefit
of borrowers.
Slide 7: Should the government pay?
The purpose of the Bank Recovery and Resolution Directive was to en-
sure that banking crises do not jeopardise whole economies. With the
exemption applying to mortgage banks in Denmark, we have chosen to
keep up the risky ties between the government and the financial sector.
We should know better than that.
A competition-neutral and credible MREL ensures that all credit
institutions - irrespective of size and systemic importance - can be resolved
without the use of taxpayer funds and without devastating effects on the
economy. Once that is in place, credit institutions can be treated like all
other private sector corporations:
Shareholders and creditors risk losing their money and management
their jobs.
DANMARKS
NATIONALBANK
FINANCE DENMARK'S ANNUAL MEETING
Lars Rohde, Governor by Royal Appointment, 4 December 2017
The banks are
stepping on the
accelerator
Build-up of financial risks
Central bank digital currency
Three key principles for MREL
​From: Explanatory note to Act on Restructuring and Resolution of Certain Financial Enterprises, section 24(4).
Who pays the bill?
Tax payers Shareholders
and creditors