Denmark and Iceland’s Banking Sector: A Comparative Analysis

Introduction

As the European banking sector evolves, a closer look at Denmark and Iceland’s banking sector reveals distinct differences in their institution-specific countercyclical buffer rates.

Methodology Used by Danish Banks

According to a recent report by the European Systemic Risk Board (ESRB) and national authorities, the buffer requirements for institutions depend on their exposures in different countries. In Denmark, the three systemic important financial institutions (SIFIs) - Danske Bank, Jyske Bank, and Nykredit Realkredit - use internal ratings-based (IRB) models to calculate their risk weights.

Methodology Used by Faroese and Icelandic Banks

The Faroese and Icelandic banks, as well as Danish SIFI Spar Nord Bank, employ the standardized approach (SA) method. The SA method is simpler and more transparent but may not accurately reflect the actual risk of each exposure.

Risk Weights and Average Risk Weights

• The average risk weight of the Faroese banks is higher than that of the large Danish banks in group 1, while slightly lower than the medium-sized banks in group 2.
• Icelandic banks have a higher average risk weight than both Faroese and Danish banks.

IRB Methodology

The IRB method involves estimating key parameters for each exposure based on institution-specific data, such as loss history and customer individual circumstances. This approach typically results in lower risk weights compared to the SA method.

Authorization and Approval of IRB Models

The IRB method is subject to authorization by supervisory authorities, and institutions must demonstrate that their models are approved.

Icelandic Banking Sector

In Iceland, the three SIFIs - Arion Bank, Landsbankinn, and Íslandsbanki - are subject to the same buffer requirements. According to data from 2019, the average risk weight of Icelandic banks is higher than that of Faroese and Danish banks.

Capital Requirements for Danish SIFIs

The report notes that the capital requirements for Danish SIFIs are expected to increase by an average of 34% if the output floors and revised IRB method are implemented in accordance with the Basel Committee’s recommendations. A process is underway in the EU prior to implementation of these proposals in EU legislation.

Conclusion

In conclusion, Denmark and Iceland’s banking sectors exhibit distinct differences in their institution-specific countercyclical buffer rates, reflecting variations in their exposures and risk weights. As the regulatory environment continues to evolve, it is essential for institutions to adapt to changing requirements and maintain robust risk management practices.