Faroese Banks’ Risk Weights and Capital Requirements

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A recent analysis has revealed some interesting insights into the risk weights and capital requirements of Faroese banks compared to their Danish counterparts.

Lower Average Risk Weight for Faroese Banks

Despite having a larger share of loans to corporates, Faroese banks have a lower average risk weight than large Danish banks. This suggests that if given IRB permission, Faroese banks’ risk weights would not be as low as those of large Danish banks.

Higher Incidence of Losses and Impairment Charges

The study found that Faroese banks have a higher incidence of losses and impairment charges on corporate loans compared to their Danish counterparts. This is likely due to the differences in lending practices, risk assessment, and credit quality between the two countries.

Capital Requirements and Lending

Contrary to popular belief, higher capital requirements may not necessarily lead to reduced lending. In fact, empirical evidence suggests that well-capitalized institutions are met with lower interest rates on debt and a lower required rate of return on equity.

• An increase in equity makes a bank more resilient to losses on assets, which reduces the risk for both creditors and shareholders.
• This is reflected in lower interest rates and a lower required rate of return.

Faroese Banks’ Excess Capital Adequacy

Despite an increase in buffer requirements, Faroese banks have not seen a decline in lending in recent years. The study found that all four Faroese banks will be able to meet the phased-in buffer requirements and systemic risk buffer of 3% from January 2020.

• The banks’ primary funding sources are deposits and equity, with a share of 45% of bank deposits not covered by the deposit guarantee.
• This suggests that they may be sensitive to risks in the banks.

SIFI Requirements

As part of the study, the authors also looked at the additional requirements placed on Systemically Important Financial Institutions (SIFIs). These institutions are subject to stricter capital and liquidity requirements to reduce the probability of failure and limit the negative consequences if they do fail.

• Faroese banks will need to comply with a number of additional requirements, including a SIFI capital buffer requirement and other measures aimed at reducing systemic risk.
• The goal is to ensure that these institutions are able to withstand financial shocks and maintain stability in the financial system.