Key Issues

COVID-19 pandemic: Much of the Financial Sector Assessment Program (FSAP) work was conducted prior to the COVID-19 pandemic. Given the FSAP’s focus on vulnerabilities and policy frameworks, many of the FSAP’s findings and recommendations remain pertinent. This report includes illustrative scenarios to quantify the possible implications of the COVID-19 shock on bank solvency.

Findings: Solvency stress tests indicate that while the COVID-19 shock would have a significant and differentiated impact on capitalization ratios, all SIFIs would meet their minimum capital requirements. Given the unprecedented nature of the ongoing pandemic, these findings are associated with a substantial degree of uncertainty and subject to downside risks: A further deterioration of macrofinancial conditions could bring about a situation where some SIFIs breach their minimum capital requirements. Mortgage credit institutions play a central role in the domestic interbank system and can generate significant contagion effects.

Policies: Danmarks Nationalbank (DN) promptly provided liquidity support in response to the intensification of the crisis and has launched liquidity facilities and has reactivated swap lines. Looking ahead, DN should continue to enhance its operational preparedness for nonstandard liquidity support, including by refining the framework for accepting credit claims as nonstandard collateral. Notwithstanding a significant strengthening of the crisis management framework in recent years, the autonomy of the resolution authority should be strengthened, resolution planning for systemic institutions should be accelerated, and strategies for liquidity assistance to institutions in resolution should be defined. The operational independence of the Danish Financial Supervisory Authority (DFSA) should be safeguarded and it would benefit from a further increase in resources. The DFSA must complement its strong credit risk skills in banking with equal rigor in other areas (such as governance, compensation practices, and risk culture). Denmark should continue strengthening AML/CFT supervision, including by intensifying on-site inspections of higher-risk financial institutions. Going forward, to reduce inaction bias, the institutional arrangements for macroprudential policy can be improved by streamlining the decision-making process.

Approved By

James Morsink and Mahmood Pradhan

Prepared By

Monetary and Capital Markets Department

• The FSAP team was led by Selim Elekdag (Mission Chief) and Mario Catalán (Deputy Mission Chief) and included Mark Buessing-Loercks, Ibrahim Ergen, Ziya Gorpe, Jan Philipp Nolte, Umang Rawat, and Katharine Seal (all MCM), Olamide Harrison (EUR), Deeksha Kale (MCD), Jay Purcell (LEG), Timo Broszeit and Jane O’Doherty (experts). At headquarters, Elizabeth Mahoney provided research support and Kateryna Botsu provided administrative and editorial assistance.

• The mission met with senior Danish officials, including the Governor of the DN, the Director General of the DFSA, the Chief Executive Office of the Financial Stability Company (FSC), members of the Systemic Risk Council (SRC), as well as senior management and staff at the Ministry for Industry, Business, and Financial Affairs (MIBFA), DN, DFSA, and FSC. The mission also met with senior counterparts at banks and insurance companies as well as academics, think tanks, and industry representatives.

• FSAPs assess the stability of the financial system as a whole and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• Denmark is deemed by the Fund to have a systemically important financial sector according to Mandatory Financial Stability Assessments Under the Financial Sector Assessment Program—Update (11/18/2013), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the Fund’s Articles of Agreement.

• This report was prepared by Selim Elekdag and Mario Catalán with contributions from the FSAP team.