Danish Banking Seminar March 8 2016 Jesper Berg

Danish Banking Seminar March 8, 2016 Jesper Berg, Director General Danish Financial Supervisory Authority

Agenda • • Earnings and capitalisation CRD phase-in and Basel IV IFRS 9 Supervisory Diamond – upcoming changes Net Stable Funding Ratio (NSFR) Minimum Requirement for own funds and Eligible Liabilities (MREL) Stacking order (MDA) New challenges and the future for the Danish FSA 2

Earnings and Capitalisation

Positive and increasing profits for banks 4

Impairments are decreasing … … Low interest rates squeeze core earnings 5

Bank lending continue to drop…. … while mortgage lending rises 6

Bank capitalisation has improved since the financial crisis 7

Build up buffers during good times …not during bad times 8

Capital depletion? • Capital ratios can be maintained with high pay-outs when lending growth is low and/or Ro. E are high • …but not if lending growth resumes and/or Ro. E targets are not met Development in CET 1 ratio for different levels of lending growth and dividend policy (Ro. E assumed=15%) (Ro. E assumed=8%) 9

Will pre-crisis Ro. E-levels return? 10

Probably not, because: • • Low risk free rate Low growth No margins on deposits High capital levels (structural) …Especially low in the short term 11

Realistic ROE and sustainable dividends • Market pressure for higher dividends to increase ROE, but: • Low interest rate reduces short term ROE for financials § and for banks funded by deposits it reduces profits and ROE even more • Higher capital level reduces risks of shareholders § Reduces long term ROE • In the long run with normal growth and ROE paying out 75 per cent of profits is not sustainable. • Important to build up capital reserves during good times 12

Challenged banks • In general, the Danish banking sector is robust • Still a small group of banks on intensified supervision due to potential solvency problems during the next 12 -18 months Market share of challenged banks 30. 06. 2014 30. 09. 2015 Loans 3. 6 per cent 3. 2 per cent Total assets 2. 6 per cent 2. 4 per cent 13

CRD phase-in and Basel IV

BCBS consultative documents (Basel IV) –IRB floor • The standardized approach is revised – the risk weight is determined on the basis of risk factors for a range of exposure types • The IRB floor will be based on the revised standardized approach § § Separate floors for credit-, market- and operational risk as well as exposure classes are under consideration The floor might be determined as a floor for the risk weighted exposures • The consequences will depend on the final calibration of the standardized method for credit risk and the floor (today 80 per cent of the Basel I capital requirement) • QIS-exercise in progress – revised proposal expected in 2016 • If the floor is implemented in the EU as a floor for the risk weighted exposures, this could mean that the combined buffer requirement has to be determined on the basis of the floor of the risk weighted exposures and put on top of the IRB-floor. 15

Possible effect of implementation of a new IRB floor Example on the effect of a floor under the risk weighted exposures 25 % of REA Current requirements • New requirements A change to the floor for the risk weighted exposures may have an impact for some of the Danish IRBinstitutions, as § 20 § 15 • 10 This is easily demonstrated by a simple example where § 5 • 0 Solvencyrequirement incl. Buffers Capital New floor Basel I-floor (80 pct. ) Basel I floor Buffer Capital requirement incl. Buffers Pillar 2 The buffer requirement is calculated on the basis of the floor The buffers are added to the capital requirement calculated on the basis of the floor The buffer requirement, calculated on the basis of the current floor, is added to the current Basel I-floor For three out of the five large IRBinstitutions, the capital requirement will increase § By an average of approx. 5 per cent of RWE For simplicity pillar 2 is assumed fully covered by pillar 1 16

The Denominator and IRB modelling • High capital requirements incentive to REA optimization • REA differences to be addressed: § Should be based on the actual differences in risk • The Danish FSA believe in IRB modelling. But will continue to be skeptical of changes to the IRB framework, which can lead to significant reductions in REA 17

IFRS 9

New accounting standard – IFRS 9 • The existing impairments model featured impairments at ”incurred losses”, which turned out to be too little and too late during the financial crisis. • IASB and FASB was therefore encouraged by the G 20 and The Financial Crisis Advisory Group (FCAG) to develop an alternative model that took the future and expected credit losses better into account. • The impairments model therefore moves from incurred to expected losses. • The new IFRS 9 comes into force on the 1 st of January 2018 at the latest. EU-approval is pending. 19

3 stages in the IFRS 9 impairments calculation Significant increase in credit risk Stage 1 Stage 2 Stage 3 Accounting for expected losses Expected loss on a 12 month horizon Expected lifetime loss Accounting for interest rate income Effective interest rate based on gross lending Effective interest rate based on impaired lending 20

Supervisory Diamond – Upcoming changes

Supervisory Diamond for banks - upcoming changes Supervisory Diamond today: ∑ large exposures < 125 per cent Funding-ratio < 1 Lending growth < 20 per cent Commercial property exposure < 25 per cent Excess liquidity coverage > 50 per cent • New benchmark for large exposures change January 1 st, 2018 • New benchmark for excess liquidity coverage will be based on LCR when the section 152 requirement is phased out • New benchmark for funding await greater clarity on upcoming EU requirements 22

Net Stable Funding Ratio

NSFR – Net Stable Funding Ratio • The EU Commission will present a legislative proposal concerning NSFR before the end of 2016. • It is important how Danish covered mortgage bonds issued under L 89 will be treated for the issuing institution in the European NSFR. § § • In the Basel version of the NSFR it is possible to net certain interdependent assets and liabilities, which takes them out of the NSFR calculation. § § • The bonds will affect the NSFR negatively if the bonds are considered short as according to their contractual end date. It has been ensured with L 89 that the issuer have available funding during the entire lifetime of the loan, and hence could be considered long and stable funding. It is a requirement that the asset and the liability have the same maturity. The expectation is that 30 year mortgages funded by 30 year mortgage credit bonds will be netted out of the NSFR. It is the opinion of the Danish FSA that mortgage credit bonds issued under L 89 should be considered stable funding. 24

MREL

Background – New areas of interest concerning bank resolution Focus is now on: • Resolution plans and continuation of critical functions • MREL-requirements • Barriers to resolution 26

Principles for resolution • • • No bank should go into disorderly resolution – all critical functions should continue Depositors should have access to their accounts Monday morning MREL Potential losses associated with bank resolution or restructuration should be borne by banks (i. e. owners and holders of loss absorbing capital) – not the public Non-SIFI banks: • After restructuration, control should be given to the creditors who have become owners as fast as possible • Alternatively assets should be sold to other banks SIFI banks: • Restructuration and back on the market 27

Future process for MREL and resolution planning • Working deadline for the first resolution plans and final MRELrequirements is end of 2016 • Continued dialogue with the sector during 2016 • Level 2 regulation from the Commission concerning MREL is still not ready MREL 28

What does a resolution plan consist of? A resolution strategy Effective communic ation Scenarios & possible resolution mechanisms 29

Stacking order - MDA

Danish FSA approach to calculating MDA • The Danish implementation of the MDA calculation follows the text of CRDIV art. 141(6) closely. § • Only CET 1 capital used to meet requirements under CRR art. 92(1)(c) is excluded when determining the MDAfactor. The Danish FSA notes the view of the EBA opinion encouraging the Commission to review article 141 of the CRDIV with a view to avoiding differing interpretations of article 141(6).

New challenges and the future for the Danish FSA

Earned trust – a common interest • In God we trust… 33

Current challenges for the financial sector Technological developments Stronger regulation • New actors • Fintech • Distribution • CRD IV / CRR • NFSR / LCR • MREL Earnings • Low interest rates • Low economic growth The Financial Sector 34

Finance at zero interest rates • ”Only three people […] have ever really understood the Schleswig. Holstein business - the Prince Consort, who is dead—a German professor, who has gone mad—and I, who have forgotten all about it. ” • The banking business model: § § § Cheaper funding than the market rate? Maturity transformation? Credit specialists? • Pension and insurance = Asset management? 35

New actors and shadowbanks • What is a shadow bank? • Regulation has tightened. This creates room for new financial agents • Technological development and Fintech leads to ever stronger competition • The combination of low interest rates, regulatory pressure, and Fintech leads to …? • Is this the beginning of the end for the traditional universal bank? 36

Technological developments and new agents • Technological developments allows renewed competition in core banking areas § § § Payments Distribution Financial services • This might create competition in areas that previously was undisputed bank territory … might pressure traditional banks

Fin. Tech 38

The universal bank is challenged • Traditional banking have a more costly business structure due to branches providing personal financial advise • Is it still profitable to bundle together deposit taking, lending, payments, investing, and retirement saving? • Has the universal bank survived due to consumer preferences or a historically competitive business structure? 39

How important is costumer contact? • Costumer systems • Accounts • Infrastructure 40

Implications for the FSA • We pay attention to new business models • We strive to strike a balance between • An environment that supports technological development • Protecting the individual costumer and the financial stability • A level playing field 41

Yet, the goal remains the same The FSA works for financial stability and trust in the financial institutions and markets. … the 3 main themes remain: • Counteracting that financial institutions get into trouble • Assessing the viability of financial institutions’ business models • Incorporating the systemic perspective in our supervisory work 42

An adjusted course… 1. A more balanced political mandate 2. Uncertainty about economic and financial developments, although the most likely scenario is normalisation 3. Regulation is an international affair 4. Digitalisation and new business models are already here 5. It is a vulnerable, interconnected, and complex system 6. Denmark is an outlier concerning pensions and insurance, and mortgage credit. We risk getting run over 7. Risks are moved from the public to the private 43

Eight possible areas of interest 1. Supervision during the calm 2. Supervising systemic risks 3. Functioning financial markets 4. Supervising cyber risks and new business models 5. Protecting the consumer interest 6. Early international protection of national interests 7. Retention of key competencies 8. Beyond professionalism 44