Nils Bernstein: Challenges ahead for the Danish economy
Speech by Mr Nils Bernstein, Governor of the National Bank of Denmark, at the Annual
Meeting of the Danish Bankers Association, Copenhagen, 6 December 2010.
* * *
The world economy is slowly emerging from the crisis. Global developments are diverse, with
strong growth in the Asian emerging economies and parts of South America and slower
growth in the old industrialised countries. It remains uncertain to which extent private
consumption in the USA and Europe will take over when the government stimulus
programmes expire and the necessary fiscal consolidation starts. High rates of unemployment
and uncertainty about the future will dampen private consumption. Investment will gradually
begin to fuel the economy again, while the contribution from stock rebuilding will fade away.
In Germany and Sweden - Denmark's two largest export markets - growth has been
surprisingly positive so far. For Denmark, Danmarks Nationalbank expects growth in the
coming year to be just under 2 per cent, driven by moderate increases in private
consumption, business investments and exports.
The outlook is still subject to considerable uncertainty. The economy is presumably more
likely to underperform than to exceed expectations.
The developments on the Korean Peninsula remind us how strongly we can be influenced by
uncontrollable events far from our part of the world.
In Europe we have recently witnessed at close hand what the consequences can be when
markets lose confidence in the ability of sovereign states to manage their own debt
problems. First it was Iceland, then Latvia, then Greece and now Ireland. Where will it all
end?
Fortunately, Europe has so far been willing and able to lend a hand in collaboration with the
IMF. But if confidence is to be restored, the member states in question must make drastic
cuts in public-sector wages, pensions, etc. while also raising taxes substantially. This goes
hand in hand with social unrest and loss of international reputation.
Denmark is also facing a number of fiscal challenges. They are not as severe as in many
other countries, but nevertheless they must be addressed in time so that they do not grow.
The economic recovery plan deals with the period until 2015, but after that adverse
demographics will increase the government deficit for many years - unless action is taken.
If we in Denmark are to avoid government debt growing to unmanageable proportions in the
long term, we will need to increase taxes, adding to the already heavy tax burden, and put a
much tighter rein on public spending than ever before. In addition, we need labour market
reforms to boost the supply of labour substantially. The sooner we start implementing such
reforms, the better. This will give us more room for manoeuvre.
Danmarks Nationalbank eagerly awaits the forthcoming plan that will chart Denmark's
economic policy course until 2020. Confidence in the Danish economy will be strengthened,
if broad agreement can at least be reached on the scope of the challenge.
* * *
The financial system is recovering. If the Danish economy develops in line with our
expectations, the banks will generally be resilient to the coming losses. But in view of
uncertainty concerning the economic outlook , several banks would be wise to build up
further buffers.
* * *
Now that the Danish banks are emerging from the crisis, it is also time to consider how we
can prepare ourselves better for future financial crises.
At the end of September the general government guarantee covering the banks' unsecured
creditors expired. Happily for us all, this took place without major problems. But the sector is
not yet standing on its own two feet. The government has injected kr. 46 billion in subordinated
capital and given guarantee commitments for a further kr. 364 billion. As these schemes
expire, they must be replaced by market-based solutions. At the same time, the banks must
prepare for tighter regulation and supervision in future.
The challenge is to ensure a robust financial system that can survive without government
assistance next time a crisis occurs.
Credit will be more expensive and harder to come by. Banks, companies and households will
all have to accept a higher equity share when operating a business or purchasing a home.
This is not a purely Danish challenge. Many international forums are working hard to define
common standards for the financial system to make it more robust and self-contained.
However, the future international standards may not be sufficient to ensure a robust and
selfcontained Danish financial system in due time. Or perhaps they will not take Danish
experience into account to a sufficient degree.
Let me mention a few areas that will be important to consider in a Danish context.
The Basel Committee's proposals for new liquidity rules and the status of mortgage bonds
when calculating the new liquidity buffer have for good reason been prominent in the Danish
debate. Efforts are still underway to amend key elements of the rules. But I think the sector
will have to face the fact that self issued bonds cannot be included in the calculations.
And after all, if you want a sound liquidity buffer, it does actually make sense that the value of
this buffer is - as far as possible - independent of your own situation.
The stable financing requirement has been postponed until 2018. The debate on the
consequences for adjustable-rate loans has died down. On several occasions, Danmarks
Nationalbank has expressed its concern about the refinancing risk on these very popular
loans. The idea behind the stable financing requirement has indeed been to reduce this type
of refinancing risk. Although the proposal has been postponed, this risk is very real in
Denmark. Some banks spread out their auctions over the year, while others have,
unfortunately, not come that far with existing loans. Spreading out the auctions is a good
principle, but not sufficient to solve the basic problem. A solution needs to be found before
2018.
The global financial crisis has evolved differently from country to country. But there have
been common traits - such as property market developments. Rapidly rising property prices,
very strong housing and property investments and high lending growth for financing such
investments have all contributed to the financial crisis. That has also been the case in
Denmark.
The Danish banks that have succumbed to the crisis or have been close to the brink have all
been characterised by very high lending growth and an almost aggressive exposure to the
property sector. These factors contributed heavily to the build-up of systemic risk in the years
leading up to the crisis.
The Basel Committee has proposed that the financial institutions not only hold an extra
capital buffer on a permanent basis, but also hold a countercyclical capital buffer. In good
times, when lending growth is high, restrictions may be imposed on disbursement of dividend
if the accumulated reserves are insufficient. This will dampen strong cyclical upswings. When
the tide turns, the additional reserves are released.
It is still uncertain whether this model will be sufficient to address the role of the property
market and its financing in relation to financial stability in Denmark. Several countries have
tightened or are thinking of tightening the conditions for mortgaging real property or the
capital requirements imposed on the lender. Such instruments come in many shapes and
can be linked to cyclical developments.
It will be a challenge to develop efficient economic instruments in a world with free flows of
capital - not least within the EU. This openness is a great advantage to Denmark, but as
Danmarks Nationalbank sees it, we need to consider whether we can introduce instruments
in this area that will support financial stability. Preferably such instruments should be a kind
of automatic stabilisers. If not - they should be available to the Danish Financial Supervisory
Authority and Danmarks Nationalbank.
* * *
The financial crisis led to a very important piece of legislation in Denmark. The general
government guarantee has been replaced by a winding-up scheme for banks - known as
Bank Rescue Package III - that provides for orderly winding-up of banks that cannot
continue as going concerns under their existing ownership. From society's point of view it is,
as I have previously underscored, not important whether the individual bank survives, but
whether sound activities can continue without interruption. People must be able to access
their accounts, use their debit cards, pay their bills on time, etc. Unfortunately, the current
legislation does not make it mandatory for banks to join the scheme, but merely to decide at
a general meeting whether they want to join the scheme now. If they say no, this generates
uncertainty as to whether they will join if the need arises.
During its recent visit, the IMF took a positive approach to the Danish winding-up scheme
and recommended that banks which do not join beforehand are subjected to additional
capital requirements. I hope we find a voluntary solution, and today I will merely encourage
banks to join the scheme at their forthcoming general meetings.
With this well-intentioned advice I would like to express my appreciation to the Danish
Bankers Association and its members for our cooperation over the past year.
Thank you for your attention.