Title: Faroese Banks Face Tightening Compliance Regulations: Danish and Faroese Systemic Risk Councils Deliberate

Analysis of Regulatory Requirements for Faroese Banks

The Danish Systemic Risk Council, in collaboration with Føroya Váðaráð, the Faroese Systemic Risk Council, has analyzed the regulatory requirements for Faroese banks following a review of systemically important financial institution (SIFI) thresholds in March 2019. The Danish Risk Council, comprised of representatives from both Denmark and the Faroe Islands, has determined that the current capital buffer requirements for banks in the Faroe Islands are appropriate.

Faroese Economy’s Financial Sector Regulations

In the financial sector, the Faroese economy is subject to Danish policies and regulations, including those concerning capital buffers. The Danish Financial Supervisory Authority (FSA) is responsible for overseeing Faroese banks, while the Danish Minister for Industry, Business and Financial Affairs decides on capital buffer requirements. In turn, the Danish Risk Council identifies and monitors systemic financial risks in the Faroese Islands to recommend macroprudential measures if necessary.

Macroprudential Requirements for Faroese Banks

Faroese banks, like their Danish counterparts, must comply with a range of legislative requirements, such as Pillar I and II obligations, capital buffer requirements, and MREL (Minimum Requirement for Own Funds and Eligible Liabilities) requirements (1). Besides universally applied capital conservation buffers, the buffers addressing systemic risks are determined based on local conditions (2). These three buffers, referred to as macroprudential requirements, are overseen by the systemic risk councils in Denmark and the Faroe Islands.

Post-2008 Global Financial Regulations and Their Impact on Faroese Banks

After the Financial Crisis of 2008, global financial regulations have tightened to strengthen the resilience of the financial sector. The Danish financial system, including the Faroese economy, adheres to these stricter guidelines to ensure stability in the face of potential future financial crises (3).

Capital Requirements in the Faroe Islands

Importance of Capital Requirements for Financial Stability

Capital requirements are a critical component of financial stability, with insufficient capitalization increasing the likelihood of financial sector difficulties spreading from one institution to others. The Faroese economy, due to its small size and open business structure, requires appropriately higher capital requirements than those in Denmark (3).

Determination of Capital Requirements

Despite their differences in risk weights, the Faroese and Danish SIFI’s risk-weighted exposures are used to determine capital requirements. The average risk weights of Faroese SIFI’s are generally higher due to differences in their portfolios and risk calculation methods, resulting in higher capital requirements relative to their Danish counterparts.

Effects of Increased Capital Requirements on Lending

The impact of increased capital requirements on lending by banks is complex, contingent on the economic and financial circumstances. In the Faroe Islands, capital requirements have risen along with total lending as the economy has experienced an upswing. However, Danish mortgage credit institutions’ lending in the Faroe Islands has significantly increased since 2018, which could potentially offset the effects of higher capital requirements for Faroese banks in the context of local conditions (6).

Conclusion

Understanding the financial compliance regulations in the Faroese Islands, including the role of capital buffers and SIFI designations, is crucial for both local and international stakeholders in the Faroese economy. The Danish and Faroese Systemic Risk Councils’ collaborative efforts offer a framework for ensuring the financial stability of the Faroese economy.

1. Pillar I obligations: regulations requiring banks to hold a certain amount of capital against their risks.
2. Pillar II obligations: regulatory requirements for banks to hold capital to cover potential losses from specific risks, such as market risks and operational risks.
3. Minimum Requirement for Own Funds and Eligible Liabilities (MREL): a regulatory requirement for banks to maintain a minimum level of own funds and eligible liabilities for absorbing potential losses.