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Stricter capital rules uncalled for, Denmark's mortgage bankers say

Danish bankers are protesting against a proposal to implement stricter capital rules around mortgage lending, saying the country's unique mortgage bond model is safe enough already.

The Danish central bank said Jan. 18 the country's banks should no longer be exempt from the minimum requirement for own funds and eligible liabilities, or MREL European bail-in rules designed to minimize taxpayer losses if any of them get into trouble in the future.

The changes would translate to extra costs of between 200 Danish kroner and 1,100 kroner per 1 million kroner borrowed, which the central bank says would be a low price to pay to protect the mortgage credit sector. Total outstanding Danish mortgage bonds in issue as of 2015-end totaled €375 billion, or 144% of GDP, according to data from the Association of Danish Mortgage Banks.

But the proposals have met with criticism from banking industry figures who say things work well enough as they are. Denmark's mortgage system functions differently from those of most other European countries, with specialist banks issuing mortgage bonds rather than full-service banks holding the loans on their own balance sheets. This mortgage bond market has never seen a default in its 220-year history.

Overzealous regulation

Mortgage banks already have a debt buffer of 2%, which is enough to ensure that they can keep going in the event of a crisis, according to Peter Jayaswal, deputy director at FinansDanmark, the main Danish financial services lobby group.

In case of resolution, the debt buffer can be used by authorities to recapitalize the mortgage banks when using tools in the EU's Bank Recovery and Resolution Directive other than the bail-in tool, he said in an email.

Mortgage banks should not be subjected to the same MREL requirements as universal banks, because they are not allowed to take deposits, and the scenario for their resolution would be very different in the event of a crisis from that of a full-service bank, Jayaswal said.

The CFO of Sydbank A/S, Jørn Adam Møller, agrees that the central bank's proposals are overzealous. Sydbank is one of Denmark's top five banks by working capital.

"I don't think [the change] is necessary," he said in an interview. "The central bank governor is very risk-averse and is making a lot of noise about how the banking sector needs more capital. Essentially the regulators and the central bank are trying to make sure that nothing bad happens on their shift, but I think they should stop imposing additional regulations."

New MREL requirements would make mortgages more expensive for banks' clients, but not catastrophically so, Møller said.

"Prices could go up by 20 or 30 basis points, but customers can live with that," he said. "There won't be a major impact." He added the change would not impact Sydbank directly because virtually none of the mortgages it writes appear on its own balance sheet. In the case of retail mortgages, most of the loans it writes are financed by mortgage bank Nykredit Bank A/S.

Insolvency procedures 'insufficient'

A source close to the central bank said the additional regulations had been proposed because current insolvency procedures prescribed by Danish law would be "insufficient" to cope if a mortgage bank were to go bust.

"The central bank doesn't question the stability of the Danish mortgage bank system," the source said, who wished to remain anonymous. "The question is, if a mortgage bank were ailing, could we handle it within the existing legal framework? We need an MREL requirement up front, as a cushion. There is no point coming up with MREL when you are in a bad situation. It needs to be done up front."

The source stressed that mortgage bonds are a "very large and very concentrated" part of the market.

The MREL proposal comes as Danish banks await possible additional capital requirements under so-called Basel IV global rules, which would restrict the ability of banks to use their own in-house models to calculate risk weightings. European regulators are concerned that Europe's banks would be particularly badly hit; the Danish Bankers Association has voiced concerns that higher Basel IV capital requirements for Danish banks would be disproportionate to their low-risk portfolios.

Nykredit, the largest of Denmark's mortgage banks, said in March 2016 that it planned to hike mortgage fees to mitigate the impact of new Basel capital rules.

Nykredit declined to comment. Basel IV negotiations are currently on ice.