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Faroese Banks’ Risk Weights and Capital Requirements

A recent analysis of the financial statements of Faroese banks has revealed that they have a relatively low total average risk weight, which can be attributed to their high share of exposures secured by mortgages on real estate. This is in contrast to medium-sized Danish banks, whose risk weights are slightly higher.

Breakdown of Risk Weights by Segment

• Large Danish banks have a larger share of loans to corporates than Faroese banks and other Danish banks.
• The internal ratings-based (IRB) approach used for corporate exposures results in significantly lower risk weights compared to the standardised approach (SA).
• These IRB risk weights are influenced by individual circumstances, loss history, and may vary over time.

Impairment Charges and Losses

Despite having a lower total average risk weight, Faroese banks have posted higher losses and impairment charges than Danish Systemically Important Financial Institutions (SIFIs) with IRB authorisation. This suggests that if given IRB permission, the Faroese banks’ risk weights would not be as low as those of the Danish SIFIs.

Capital Requirements and Lending

Higher capital requirements are often associated with reduced lending and higher lending rates. However, empirical evidence suggests that well-capitalised institutions are met with lower required returns on debt and equity. This is because an increase in equity makes a bank more resilient to losses on assets, reducing the risk of creditors suffering losses.

Adjusting to Higher Capital Requirements

Banks can adjust to higher capital requirements by:

• Increasing their capital through retained earnings or new market capital
• Reducing their risk-weighted assets
• Reducing their excess capital adequacy

In practice, the effects of these adjustments will depend on the financial and economic situation.

Excess Capital Adequacy in Faroese Banks

Despite an increase in buffer requirements, there have been no signs of a decline in lending in the Faroe Islands. The four Faroese banks are expected to meet the phased-ín buffer requirements and systemic risk buffer of 3% from January 2020.

Capital Requirements and Excess Capital Adequacy

Table 4 shows an overview of the capital buffer requirements and excess capital adequacy of the four Faroese banks. The banks’ primary funding sources are deposits and equity, with a share of 45% of bank deposits not covered by the deposit guarantee scheme.

SIFI Requirements

Systemically Important Financial Institutions (SIFIs) are subject to additional requirements to reduce the probability of failure and limit negative consequences in case of failure. These requirements include a SIFI capital buffer requirement, which applies to institutions designated as SIFIs.

[Insert Table 4]

The analysis highlights the importance of considering the risk weights and capital requirements of Faroese banks, particularly in light of their designation as Systemically Important Financial Institutions (SIFIs). The findings suggest that these banks are well-capitalised and have a low total average risk weight, but may still be subject to additional requirements due to their systemic importance.