Hybrid Debt Experiments by Financial Supervisory Authority to Help Banks in Denmark

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The Financial Supervisory Authority (FSA) in Denmark said that banks facing stricter individual capital requirements will be allowed to use new hybrid debt instruments to build their regulatory buffers. Denmark, which has been hit hard by the global financial crisis, will be free to use the bonds which will convert into equity and debt which can absorb losses before a default, said Ulrik Noedgaard, director general of the Financial Supervisory Authority in an interview with media persons. This decision by the financial watchdog in Denmark puts an end to the speculation by banks in Denmark on their obligation to fulfill lender specific requirements using only equity. Financial institutions were notified in March this year that they need to hold atleast 5 percent points extra capital, which has been debated extensively by lawmakers. Banks have argued that the pressure to build reserves has restricted its lending abilities as capital costs rise. Noedgaard, head of the financial dog said “We think we’re coming with a solution that will address their concerns. Although the point of reference for us is that these buffers would have to be filled with common equity Tier 1, we are also happy with having some kind of capital in place that has the same properties”. The FSA plans to shed more light on the types of hybrid instruments that can be used by next week. The emphasis will be on such instruments which have the ability to sustain loss bearing potential while the bank is still solvent. Banks will be allowed to use the hybrids to fulfill individual solvency buffers above a minimum of 8 percent equity requirement. Another advantage of relying on debt is they hide the potential risks as rating companies redefine their assessments of the securities. However, DANSKE’s ability to plan its capital structure is being hampered by the prospect of a change in rules at Standard & Poor. S&P had said in March that it is reviewing its criteria for risk adjusted capital in a possible move that could threaten to reduce the loss bearing potential of a $ 1 billion 2037 bond that Denmark issued in December. S&P had asked banks to submit a feedback on a proposal to revise its hybrid capital criteria. The rating had said that it was considering the changes “To further emphasize regulatory classification in our assessment of whether an instrument is able to absorb losses while the bank is a going concern”. The chief of Denmark’s financial watchdog said FSA is aiming to create standards that would ensure that hybrid securities offered by the nation’s banks follow rules enforced elsewhere. Noedgaard said, “We are aiming to come up with demands that are consistent with what you see in other countries, so it should also be possible to issue for Danish banks”. Though it would not be limited to Sifis, the instruments will render their capital requirements.

Danske Bank and Nykredit A/S, the country’s biggest mortgage lender, are now lobbying lawmakers to reject the proposals.

Sifi Committee

The government had appointed the Sifi committee in March which identified Denmark’s six biggest banks as systematically important to the $ 300 billion economy and argued the lenders should hold as much as 5 percent extra capital. This move has sparked of a series of steps that has placed Denmark at the forefront of regulatory reforms in the European Union.

The financial industry of Denmark is oversized with it assets nearly four times of the size of the economy. Danske Bank’s assets alone are close to twice Denmark’s GDP.

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