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Denmark’s and Iceland’s Banking Systems Under Scrutiny

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Denmark’s banking sector accounted for approximately 358% of the country’s GDP in December 2020, while Iceland’s banking sector represented about 72.7% of its GDP in February 2020. A closer look at the institutions’ risk-weighted exposures reveals varying approaches to calculating their capital requirements.

Buffer Requirements

Institutions’ buffer requirements are calculated as a percentage of their risk-weighted exposures. The three Icelandic SIFIs (Systemically Important Financial Institutions) are subject to the same buffer requirements, which depend on institutions’ exposures in different countries according to European Systemic Risk Board and national authorities’ websites.

Risk-Weighting Methods

Danish banks use a combination of standardized approach (SA) and internal ratings-based (IRB) models to calculate their risk weights. The SA method divides exposures into categories with internationally determined risk weights, while the IRB method requires estimating key parameters for each exposure based on institutions’ own data.

Comparison between Danish and Faroese Banks

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

IRB Method for Faroese Exposures

Use of the IRB method for credit risk on Faroese exposures by an IRB institution is subject to authorization by the Danish FSA. If an institution’s IRB authorisation does not include Faroese exposures, it must apply the standardized approach to calculate credit risk.

Outlook

The implementation of the Basel Committee’s proposals, including the output floor and revised IRB method, is expected to increase capital requirements for Danish SIFIs by an average of 34%. The EU is currently reviewing these proposals before implementing them in legislation.

Conclusion

Denmark’s and Iceland’s banking systems face different challenges when it comes to calculating their risk-weighted exposures. While the three Icelandic SIFIs are subject to the same buffer requirements, Danish banks use a combination of SA and IRB methods. The Faroese banking sector has a higher average risk weight than some Danish banks, while Icelandic banks have a significantly higher average risk weight overall.

Sources

• European Systemic Risk Board
• National authorities’ websites
• Financial statements of Icelandic banks