Major Factors

Rationale

S&P Global Ratings classifies the banking sector of Denmark (unsolicited: AAA/Stable/A-1+) in group '3' under its Banking Industry Country Risk Assessment (BICRA) methodology. Other countries in group '3' are Australia, France, the Netherlands, the U.K., and South Korea (see chart 1). Our bank criteria use our BICRA economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in Denmark is 'bbb+'.

Chart 1

Our assessment of low economic risks for Denmark reflects our view that Danish banks benefit from operating in a high-income, open economy with mature political and institutional settings that promote fiscal discipline and growth-stimulating policies. The economy is competitive and diverse, and we expect it to show more resilience than its Nordic peers in the midst of the COVID-19 pandemic. This, as well as the robustness of its welfare system, and the government's policy response to the pandemic are, in our view, efficient mitigating factors against the potential pressure that the situation creates for banks' asset quality. Overall, we expect bank provisioning needs to peak in 2020 at 35 basis points (bps) of the total sector loans, mostly driven by non-mortgage credit exposures toward small and midsized enterprises, a level which rated systemic Danish banks' can accommodate with their capital buffers. The robustness of the mortgage sector, representing two thirds of total lending, is in our view further supported by a balanced housing market. We expect the current economic pressure to only generate a minor house price correction in real terms this year, followed by a return to slow appreciation.

Although moderate, we expect increased credit losses and revenue attrition linked to COVID-19 to further pressure the sector's profitability, which remains below the broader Nordics. This anchors our current assessment of intermediate industry risk in Denmark. The frontloading of bail-inable debt issuances, negative interest rates, significant investments in compliance, and competitive pressure in corporate lending have already weighed on the sector's profitability. Factoring in the effect of the COVID-19 pandemic, we now expect Danish Bank's return on equity (ROE) to fall to 4% in 2020, close to the peer average but below the other Nordic countries. We note the banking sector's higher reliance on functioning wholesale markets than peers'. However, we also acknowledge the Danish covered bond market's continued stability and strong track record, even during the very recent market turbulence. We view the regulatory environment in Denmark in line with that of other EU countries, overall. This balances a generally robust track record of macroprudential policies and conservative bank supervision with the national anti-money laundering (AML) governance shortcomings highlighted in Danske Bank's Estonia case. However, we note the ongoing progress made by local banks and regulators to strengthen the country's overall AML framework, and expect that previously identified shortcomings are very likely to be addressed considering significant public attention and overall political consensus.

Economic And Industry Risk Trends

The trend for economic risk in Denmark is stable. This reflects our current base-case assumption that the Danish economy will remain broadly resilient to the effects of the COVID-19 pandemic, with GDP expected to contract by 5.2% in 2020--one of the mildest reductions in the peer group and the Nordics--and subsequently to rebound by 3.5%, while we expect unemployment to return below 6% in 2021, after peaking at 7% this year. In our view, this will not lead to a material or long-term contraction of property prices. Lastly, the stable trend rests on our expectation that credit risk in the Danish private sector--after receding through the last decade--will remain intermediate through the current turbulences. We expect household leverage to continue reducing as a share of GDP from next year, while interest fixing and amortization will keep increasing among Danish mortgages.

We view the industry risk trend for Danish banks as stable. This rests on our base-case expectation that moderate credit losses and weaker operating income as a result COVID-19 will reduce the banking sector's profitability in line with peer countries in 2020, but below the broader Nordics. The stable trend also reflects our expectation that the prevention of money laundering will remain a key priority for Danish political decision makers, authorities, and banks, illustrated by a continued strengthening of the country's regulatory framework and crime-fighting resources, as well as maintained strict banking supervision.

Economic Risk  |  2

We consider the Danish banking market to be protected by a resilient domestic economy, a robust social safety net, an overall sound housing market, and a recent history of receding credit risks.

Economic resilience: diversified and resilient economy with policy flexibility, despite euro peg.

Danish banks benefit from operating in a stable economic and institutional environment. Although Denmark's GDP per capita is among the highest of all sovereigns we rate, we expect it to fall as a result of the COVID-19 outbreak and measures to curb it, by 5.2% in 2020, from $59,950 in 2019.

We expect the Danish economy to be more resilient to the current economic environment than its Nordic peers, with its export components being tilted toward pharmaceuticals and agriculture, which have not been as badly hit by the blows to the economy. Pharmaceuticals constitute more than 10% of Denmark's total exports, more than twice that of other Nordic countries, and about 85% of the value is created onshore, indicating that the economy benefits directly from sustained or increasing demand. At the same time, transportation services, and shipping in particular, is an important export sector for Denmark and is likely to take a significant hit from the COVID-19 pandemic. However, close to one third of the export value is created abroad, which mitigates the transmission to the Danish economy. We expect GDP to contract by 5.2%, still a considerable fall in economic activity.

Macroeconomic policy flexibility.  Denmark maintains a fixed exchange rate to the euro, which prevailed during crisis periods, such as in 1992, 2008, and 2015. The country's monetary policy is, in our view, limited by the peg of the krone to the euro, in contrast to sovereigns that have policies involving floating and more actively traded currencies. This was exemplified in March 2020, when Denmark's central bank, Nationalbanken, increased its interest rate by 0.15 percentage points to defend its peg, following currency hedging moves.

Chart 2

We consider Denmark's fiscal policy track record to be strong. After headline fiscal surpluses between 2017 and 2019, we expect COVID-19-related measures and slowdown in the economy to lead to a deficit of 5% of GDP for 2020. We see further downside to the fiscal balance as further support measures are announced and if they continue into late 2020. As a result of the fiscal deficit and contracting economic activity we expect gross general government debt to jump from below 33% in 2019 to above 40% in 2020, which will slowly recover in the years ahead. Net debt will remain around 20%, reflecting sizable liquid assets. The trends in fiscal and debt position is similar across Sweden, Finland, and Denmark, although we expect Denmark to be marginally better off.

Political risk.  Denmark benefits from mature political and institutional frameworks. We expect the minority government, led by Social Democrats, to continue executing Denmark's prudent macroeconomic policies over our forecast--despite the highly fragmented political landscape--particularly supporting employment and fiscal discipline. The government's minority position is not unusual in Denmark, where consensus-led politics supported the past minority government in passing budgets and implementing key policies. We expect the mature political and institutional framework will continue to ensure stability and timely policy implementation.

Throughout the COVID-19 outbreak, the minority government has been able to implement support packages across the Danish economy, worth up to 20% of the country's 2019 GDP. As well as easing bank capital requirements, these packages include about Danish krone (DKK) 400 billion of measures compensating for the consequences of the country's lockdown. These include the postponement of payment of VAT and labor income tax, guarantees to corporates, and direct support measures in the form temporary wage or fixed-cost compensation for Danish enterprises. They also include a package of around DKK76 billion to support the country's economic recovery after its reopening.

Examples of similar political agreements can be found in the country's climate ambitions. On Dec. 6, 2020, the Danish parliament adopted with a broad majority a legally binding commitment to reduce the country's greenhouse gas emissions by 70% in 2030, from the 1990 levels (versus a 40% target in the EU), and reach neutrality in 2050.

Table 1

Economic imbalances: Modest credit growth and expected house price resilience.

The year 2020 and the COVID-19 pandemic have spelt the end of the Danish economy's growth phase that started in early 2014. Despite negative interest rates since 2014, nominal private sector credit growth has remained limited over the period--in particular compared with Nordic peers Norway and Sweden--and we expect this trend to continue through 2022. Similarly, microprudential measures tightening mortgage underwriting standards (see 'Lending and underwriting standards' section below) have controlled house price growth since the previous financial crisis (3.3% yearly real average since 2011), and we only expect a minor and short-lived reduction as a result of the current economic challenges.

Private sector credit growth.  We expect household credit growth to remain at 1%-2% through 2022, in nominal terms, on the back of mild short-term pressure on the housing market, despite historically low lending rates. As the economy contracts in 2020, we expect household debt's share of GDP to increase to 118%, from 112% in 2019, but that the deleveraging initiated in 2009--when the level was 144%--will continue from 2021.

Corporate debt picked up by about 6% in 2018 and 2019 in nominal terms, an acceleration from the overall stable levels registered since 2012, but far below the double-digit growth peak of 2006-2008. For 2020, we expect only a moderate increase in corporate lending, with short-term liquidity needs linked to the immediate consequences of lockdowns largely compensated by the Danish government's direct support and tax payment deferrals. Danish corporates have so far shown limited interest for the government-guaranteed lending schemes, of which only DKK5 billion had been drawn as of May 19, 2020 (of approximately DKK70 billion). In addition, Danish corporates are accumulating liquidity, with deposits up 25% year-on-year at the end of June 2020. We expect Danish firms' investment appetite to remain low in the currently uncertain business environment, leading corporate debt to reach 122% of national GDP in 2022, from 115% in 2019. Furthermore, we expect corporate lending to remain predominantly driven by collateralized mortgage credit.

Real estate prices.  We expect the current pressure on the Danish economy to have only a limited effect on house prices, namely a nominal 2.5% drop in 2020, followed by a return to 2% annual growth from 2021. This rests on our assumption that the impact of an increase in unemployment in the medium turn will be partly compensated by the Danish welfare system and COVID-19 policy response, and the currently record low borrowing costs. It also reflects our assessment that Danish house prices aren't materially overvalued on a country basis, despite imbalances in some specific markets such as apartments in the Copenhagen region. At the end of June 2020, house prices were still higher than at the end of 2019.

We also expect pressure on the valuation of certain commercial real estate segments, in particular in the hotel and retail area. Office property owners, especially those which enjoy large and creditworthy tenants, will be more protected in the short term than the retail or hotel sectors given their long-term leases and stronger tenants' fundamentals. That said, we anticipate lower demand for office space as its leasing dynamics generally find support from GDP growth, which we expect to fall by 5.2% in 2020, as well as job creations and corporates' expansion plans. This is also evident in the city center of Copenhagen where vacancy rates for offices already increased by 2% between February and April (according to The Danish Property Federation)--on the back of the coronavirus outbreak--and could rise further given the current market uncertainty. Nevertheless, we estimate that our rated office landlords will not see rents and valuations decline by more than 5% in 2020, on a like-for-like basis. We therefore anticipate the record low level of 3.5% prime yield in Copenhagen to have bottomed out. We think the residential segment will likely remain more resilient due to the structural shortage of housing in most cities, combined with tenant diversity, which should prevent landlords from experiencing material amounts of rent renegotiations or unpaid rents in the short term.

Chart 3

Equity prices.  Danish equity indices suffered as a result of the COVID-19 outbreak in February and March 2020, although less than those of other developed economies as they benefited from being overweight in health care-related stocks. The indices subsequently rallied above their February peak in mid-July. Nevertheless, the market capitalization of Danish systemic banks remains pressured versus the February peak.

Because many Danes are exposed to equity markets via private investments and pension holdings, equity appreciation in the past couple of years has improved household balance sheets and raised net financial assets to over 319% of GDP at the end of 2019. Hence, given the large financial asset positions, we expect that a more severe and long-term collapse in equity markets could weaken consumer confidence, personal financial wealth, and spending patterns.

Current account and external debt position.  For more than two decades, Denmark has posted particularly strong current account surpluses, peaking at about 9% of GDP in 2014. Even if we expect the Danish economy to be better off than its trading partners, we foresee exports and imports being hit in 2020, and that the current account surplus will drop to 4.1% this year, before rebounding to over 6% in 2021 and 2022. Notably, we expect the country's position to continue being supported by significant current income from Denmark's net wealth relative to other countries, as shown by a net external asset position.

Table 2

Credit risk in the economy: Limited loss expectations despite high leverage

Private-sector debt capacity and leverage.  Denmark ranks as one of the most indebted countries in the world on a gross basis, particularly due to the high debt level of its household sector.

Of gross Danish household debt, 85% comprises mortgages--the country's home ownership rate is over 50%--while a large share of the remainder is linked to the financing of consumer durables. Household mortgages have historically generated low losses in periods of stress, and we expect them to remain resilient during the current stress scenario. About 22% of household liabilities in Denmark are associated with self-employed households, primarily small farms, presumably more sensitive to a downturn, although agriculture has been less affected by shutdowns and restrictions than other industries. The household sector's very high debt level is partly driven by the country's tax-deductibility of interest payments, but also its pension system. Denmark's funded defined contribution pension scheme has a net income replacement rate of about 75%, in the higher range Organisation for Economic Co-operation and Development (OECD) countries. It thereby reduces the need to fully amortize mortgage debt before retirement. Danish households are among the wealthiest of the OECD in terms of their comparably high disposable income, although half of the sector's financial wealth is composed of less liquid pension assets and insurance reserves.

Combining the sector's financial assets and gross debt, Danish household's net wealth of 207% of GDP (as of end-2019) compares well with international peers.

Chart 4

In our view, the importance of interest-only loans--at 43% of residential mortgages--also encourages higher indebtedness than in markets where fixed-term amortization is the norm, as well as contributing to house price recovery in recent years. Its share of total household lending has however been in constant decline since 2013, as is the share of mortgages with short interest-rate fixings. Banks' pricing initiatives, with higher margins on more risky loans, and regulatory focus on debt maturity profiles (see 'Lending and underwriting standards' section below) have contributed to reducing these types of funding (see chart 5). We expect this level to be maintained or to decrease slightly over the next few years.

Chart 5

Lending and underwriting standards.  Since the 2008 crisis, credit conditions have tightened significantly in Denmark due to both macro-prudential regulation and market initiatives, and we so far expect the loss potential to be lower through 2022.

Selection of microprudential measures tightening credit standards:

2013:

• Requirement that all borrowers should be able to service a 30-year fixed-rate mortgage with amortization.

2014:

• Announcement of a 5% down payment requirement for new mortgage loans, and a positive cash flow requirement for all commercial property lending--implemented in 2015 and 2016, respectively.
• Announcement of the Supervisory Diamond framework for mortgage banks, introducing restrictions on mortgages with deferred amortizations or adjustable interest rates.

2016:

• Best practice rules and guidance on prudent credit assessment when granting housing loans to households with high debt-to-income ratios and insufficient wealth in growth areas.

2018:

• Restriction on loans with deferred amortization or adjustable interest rate for borrowers with a debt-to-income rate over 4x and loan-to-value exceeding 60%.

This contrasts with the credit standard deterioration that preceded the previous crisis. In particular, smaller banks used a flood of equity from the sale of their shares of Totalkredit to Nykredit in 2003 to engage in risky strategies, whereby property lending tended to be based on collateral values and agriculture loans rather than sound cash flow analysis. As a result, they incurred significant losses and several banks were wound up.

In our view, midsize banks-–defined as members of the Danish Financial Service Authority's (FSA) group two--are more exposed to increasing losses than larger rated institutions. In recent years, these banks have increased their lending to cyclical industries such as property management, construction, and agriculture, which suggests vulnerability in the sector. However, large banks--systemically important institutions contributing over 80% of lending--are reducing their exposure to those segments. The Danish central bank estimates that about 25% of midsized banks' corporate customers had low solvency at the end of 2019, compared with 10% for large banks' customers.

Overall, we believe the agricultural sector has unsustainably high debt and a large share of banks' loans to the agricultural sector are nonperforming. Pork and milk production have historically been especially troubled segments. Despite the rebound in prices during 2019--driven to a large extent by pork following the outbreak of African swine flu, which limited Chinese production--we expect both sectors to remain volatile.

Payment culture and rule of law.  Denmark has a robust payment culture and protects creditors' rights. Foreclosure of property is therefore fairly standardized. Individuals have strong incentives to pay their mortgage loans because banks have the right to claim personal income after foreclosure.

Table 3

Base-case credit losses: Low losses linked to mortgages historically and expected as a result of the COVID-19 outbreak.

Based on our current economic forecast, we are assuming credit losses to quintuple from their low 2019 level, reaching 35 bps in 2020. We estimate this level to be close to the Danish sector's through-the-cycle normalized loss rate. We expect provisioning needs to reduce by about 10 bps annually in 2021 and 2022. Credit losses could however increase further if economic contraction is sharper than we expect or recovery is delayed.

Chart 6

In our forecast, we integrate our expectation that the mortgage market will remain resilient. This is thanks to Denmark's high social safety net, household debt, and wealth distribution; its average household loan-to-value of below 45%; and a lack of material subprime or buy-to-let lending. Furthermore, high interest-only lending and historically very low lending rates, while contributing to higher debt levels overall, reduces the financial burden for many household and corporate borrowers in times of stress. We estimate the share of mortgage lending toward employees working in the industries most affected by COVID-19--such as hotels, restaurants, and transport--to be close to about 10%, which supports our expectation of resilience in our current base case. Furthermore, borrowers with the highest debt-to-income, which we expect could be more sensitive to a loss of employment, have on average the highest education and are competitive on the current labour market. This segment has accounted for less than 10% of unemployment registrations received between March 9 and May 19, 2020, according to the Danish central bank.

Our credit loss forecast is therefore largely driven by our expectation that impairments will increase for banks' lending exposures toward the industries hit hardest by the COVID-19 pandemic: hotel and leisure, retail, transport, as well as more generally export-dependent industries, oil and gas and shipping. Importantly, this marketwide forecast masks important differences between large banks and smaller institutions, whose asset quality we expect to deteriorate more.

During the previous financial crisis, higher debt levels in Denmark did not lead to higher mortgage loan losses than those experienced in countries such as Spain, the U.K., the U.S., or Ireland. Even with a 20%-30% correction in house prices after 2008, mortgage institutions reported modest credit losses, which peaked at 20 bps in 2009. Banking system losses (including corporate exposure) peaked at 1.5% in 2009, still comparing well with peers.

Table 4

Industry Risk  |  4

We base our industry risk score for Denmark on our assessment of an institutional framework overall in line with European standards, competitive dynamics showing profitability pressures for local banks, and systemwide funding supported by a stable covered bond system.

Institutional framework: Conservative supervision well in line with European standards.

Banking regulation and supervision.  The Danish banking sector remains outside of the European Banking Union and under the watch of domestic regulator, Finanstilsynet. Regardless, the regulator adheres to European principles and has implemented European banking regulations in Denmark. Finanstilsynet has identified Danske Bank, Nykredit Realkredit, Jyske Bank, Nordea Kredit, DLR Kredit, Sydbank, and Spar Nord as systemically important financial institutions (SIFI). Finanstilsynet intends to oversee banks and mortgage companies via its Supervisory Diamond framework, which provides limits on refinancing risk, concentration, credit growth, borrowers' interest rate risk, and interest-only lending.

MREL for Danish SIFI have been applicable since July 1, 2019, and were set at:

• 2x capital requirements, including buffers, or
• 8% of total liabilities and own funds (TLOF).

They are to be met with capital and subordinated instruments, but senior debt issued before Jan. 1, 2018 are included over the MREL ramp-up period through Dec. 31, 2021. Covered bond issuers are not subject to the bail-in mechanism, but are required to hold a 2% buffer of unweighted loans.

The second Banking Recovery and Resolution Directive (BRRD II)--to be transposed into national regulation no later than December 2020--sets MREL at the higher of i) 2x capital requirements and 1x combined buffer requirements, or ii) 8% of TLOF. The first limit is below current MREL subordination requirements in Denmark, which will lead to a reduction from next year.

In the wake of the COVID-19 pandemic, on May 1, 2020 Finanstilsynet announced an alignment of its requirements with BRRD II, giving a small and immediate reduction in subordination requirements for local SIFIs. Importantly, the Dec. 31, 2021 deadline for ramping up buffers hasn't been adjusted.

Regulatory track record and response to COVID-19. 

In addition to adjusting MREL subordination requirements, since March 2020, Danish regulators have enacted a range of measures in response to the economic consequences of the COVID-19 pandemic. These include a reduction of the countercyclical buffer from 1% to 0%; easing of liquidity coverage ratio (LCR) requirements; and the extension of liquidity facilities at the Danish central bank, including in U.S. dollars and euros. While these first measures support banks' lending activities in the short term, they are made possible by banks' existing capital and liquidity buffers, which we expect Danish regulators to maintain as a requirement in the long run. In June, systemic banks' median LCR increased to over 225%, from around 200% at the start of 2020. Furthermore, we consider that the Danish FSA and Danish banks hold a prudent stance toward provisioning, illustrated by the high level of loan-loss provisions already posted by Danish banks in first-quarter 2020, largely driven by management judgement and revised expected credit loss model assumptions in light of the COVID-19 pandemic.

Although it remains too early to assess the effectiveness of Danish regulatory supervision through the current crisis, these recent actions support our view of Denmark's robust regulatory track record, with a flexible and swift response to previous financial crises, a contribution to limiting unhealthy credit growth and house price appreciation since 2008, and a willingness to continually adapt its response to shifting challenges. At the same time, our view also factors in the national institutional framework's failure to prevent or limit the magnitude of Danske Bank's money laundering case in Estonia. We note, however, the constant progress made by local banks and regulators to strengthen the country's overall Anti-money Laundering framework, and believe that systematic shortcomings are very likely to be addressed considering significant public attention and overall political consensus.

Governance and transparency.  We view governance and transparency as similar to that of European peers, since the governance system is in line with that in most developed markets, and major banks have been reporting under International Financial Reporting Standards since 2007.

Competitive dynamics: Profitability pressure from increased provisions, competitive intensity, compliance costs, and MREL issuance.

Risk appetite.  Our assessment of competitive dynamics builds on our expectation that the Danish banking system's overall profitability will remain structurally in line with those of its peer countries through 2022 but below Nordic peers such as Sweden and Norway.

Chart 7

Although moderate in a European context, our expectation of increased credit losses and operating income attrition linked to COVID-19 is pressuring the sector's profitability further. The ramp-up of bail-inable debt issuances to meet MREL, significant investment in compliance, and competitive pressure on corporate lending have already strained the sector's profitability. This is further amplified by reducing mortgage administrative margins, as borrowers are switching to lower risk products, with longer interest-rate fixing and a lower share of interest-rate only loans. Still, the nominal value of Danes' total interest payments has halved since 2014 and in March 2020, for the first time, was lower than total administrative fee payments. This puts additional pressure on deposit-funded institutions, which cannot pass through the effect of Denmark's low interest rate environment as effectively as mortgage banks, despite an increasing share of customers being charged for deposits. While corporate customers have been charged for deposits over several years, only 3.5% of retails deposits had a negative rate in February 2020.

This trend already led us to factor in worsening competitive dynamics in the sector in 2019 (see "Various Rating Actions Taken On Five Danish Banks As Denmark's Banking Market Offers Mixed Blessings," published on Oct. 23, 2019). Taking into account the increased credit losses and our expectation that the COVID-19 outbreak will depress operating income, we now anticipate that Danish banks' ROE will fall from 9% in 2019 to 4% in 2020, and slightly improve to 6.5% in 2021, in line with peers and our current assessment that competitive dynamics represent an intermediate risk.

Industry stability.  Because the banking market is expanding slowly, we do not anticipate intensified competition from new entrants over the medium term. Mortgage lending is highly institutionalized, with only seven mortgage-covered bond issuers.

We consider Danish banks to be advanced in their digital transformation and benefit from broad cooperation across payment platforms--including joint payment infrastructure, payment application MobilePay, and electronic identification NemID--providing the incumbent banks with some protection against disruption. We believe most banks will follow a collaborative strategy with financial technology companies (fintechs) when launching open bank solutions. The market share of non-bank financial institutions, including fintechs, continues to be small in the Danish market, and mainly focused on specific segments such as savings (for more details on our view of the technological disruption risks for Nordic retail banks, please see "Tech Disruption In Retail Banking: Nordic Techies Make Mobile Banking Easy," published Feb. 4, 2020).

Market distortions.  Denmark does not have a tradition of government ownership in the banking sector and we do not expect the Danish government to change its ownership policy. The financial crisis resulted in the creation of government-owned Finansiel Stabilitet A/S, with the mandate to liquidate assets taken over from failed banks. However, Finansiel Stabilitet has made progress in reducing exposure and ownership of the sector.

Table 5

Systemwide funding: Stable covered bond funding compensates for the low share of customer deposits.

Core customer deposits.  Denmark's deposit base covers just over 30% of domestic loans, which is relatively little in a global context. This reflects that the Danish pension system acts as a channel for long-term savings and is the cornerstone of the large domestic bond market. Pension savings are invested in bonds issued by mortgage banks, which are not allowed to take deposits, and are therefore used to finance mortgage loans that comprise two thirds of total domestic loans. The Danish covered bond market gives mortgage borrowers direct access to the capital markets for a flat administrative fee.

Outside the mortgage market, deposits are the primary funding source. Given reduced demand for banking loans in Denmark and growth in systemwide deposits due to high savings rates in the private sector, the banking sector (excluding mortgages) operates with a small deposit surplus.

External funding.  Denmark's banking industry is highly integrated with international capital markets, and its financial institutions are net borrowers globally. The sectors' net position has improved since 2011 as demand for credit was outpaced by the increase in domestic pension savings, which are invested in domestic covered bond assets. In addition, the low issuance of government debt and very low sovereign yields have also contributed to higher domestic demand for Danish covered bonds. We anticipate that the banking sector's net external debt position will remain at about 11%-12% in 2020-2021, similar to that in 2019, with foreign creditors comprising international investors in Danish mortgage bonds, the net position of foreign bank branches, and Danske Bank's international investor base.

Domestic debt-capital markets.  Alongside Germany, Denmark is considered one of the first countries to use secured mortgage bonds to fund property purchases. Today, Denmark is the largest covered bond market in the world, with outstanding issuance exceed 2.8 trillion as of March 2020. The market stayed open during March 2020's turbulences, though at a premium, which has only partly receded as of August 2020, while issuances of senior debt and capital instruments were briefly suspended. The same pattern occurred during the financial market turmoil in 2008 and 2011, chiefly because the market is dominated by domestic investors (primarily pension funds) that have strong incentives to invest under almost all conditions and have a continual inflow of funds to do so. Even with negative yields on Danish covered bonds, the mortgage bond market has remained a more stable source of funding for the banking sector than deposits, due to the steady flow of mandatory pension savings, which need to be invested in low-risk domestic assets.

Under Denmark's balance principle, mortgage banks are required to issue bonds with the same terms as mortgage loans--in other words, customers' demands determine the features of mortgage bank's covered bond liabilities. Borrowers' appetite for longer maturities have hence contributed to reducing Danish bank's reliance on short-terms wholesale funding, thereby strengthening their funding profile.

Government role.  From 2008 to 2011, the Danish government maintained a strict divide between taxpayers' money and the banking system, and charged market rates for any support provided, as stance we would expect it to continue maintaining. Given the importance and size of the domestic covered bond market, authorities implemented legal changes that have transferred refinancing risk from the issuer to the investor, and continue to display the market's benefits and stability internationally. Furthermore, we believe that the central bank has considerable capacity to support bank funding and liquidity, which supports our overall systemwide funding assessment.

Table 6

Peer BICRA Scores

Table 7

Government Support

We classify support from the Danish government to its banking system as uncertain following its implementation of the European Bank Recovery and Resolution Directive, and consider the resolution regime as effective.

The Danish implementation of the directive introduced an exemption from the bail-in tool for mortgage banks. That said, they are required to issue a bail-inable debt buffer with a subordination requirement--equivalent to 2% of unweighted loans--in addition to meeting their existing total capital requirements. From 2022, a requirement for a minimum of 8% of a systemically important group's total liabilities and own funds will apply.

For systemic non-mortgage banks, the MREL has been set at a level equivalent to twice their risk-based capital requirement. However, the countercyclical capital buffer is included only once. As a result, the release of the buffer has reduced banks' MREL only to a small extent. MREL include a subordination requirement, to be met by the end of 2021.

The systemically important banking groups we rate in Denmark--Danske Bank, Nykredit Realkredit, Jyske Bank, and DLR Kredit--are already well advanced in their issuance of subordinated liabilities. All our ratings on those entities therefore benefit from uplift as a result of their additional loss-absorbing capacity.

The Danish FSA also published MREL for small and midsize banks in October 2017, introducing an add-on of 3.5%-6.0% of risk-exposure to be phased in by 2022.

Table 8

Related Criteria And Research

Related Criteria

• Sovereign Rating Methodology, Dec. 18, 2017
• Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
• Banks: Rating Methodology And Assumptions, Nov. 9, 2011

Related Research

• Banking Industry Country Risk Assessment Update: August 2020, Aug. 21, 2020
• The $2 Trillion Question: What's On The Horizon For Bank Credit Losses, July 9, 2020
• Global Banks Outlook Midyear 2020: A Series Of Reports Look At The Profound Implications Of The COVID-19 Shock, July 9, 2020
• COVID-19: Resilient Fundamentals And Assertive Policy Measures Will Buoy Nordic Banking Systems, Jun 16, 2020
• Tech Disruption In Retail Banking: Nordic Techies Make Mobile Banking Easy, Feb 04, 2020
• Nordic Banks' Capital And Earnings Can Weather The Weakening Credit Cycle, Nov 14, 2019
• Various Rating Actions Taken On Five Danish Banks As Denmark's Banking Market Offers Mixed Blessings, Oct 23, 2019
• Danish Covered Bond Market Insights 2019, Jul 12, 2019
• Various Rating Actions Taken On Danish Banks On Signs Of Reducing Economic Risks; Outlooks Positive, July 13, 2018