Banking Regulations and Risk Management in the Faroe Islands and Denmark

IRB Risk Weights: A Comparative Analysis

The Internal Ratings-Based (IRB) method for calculating risk weights on corporate exposures has been found to be more lenient than the Standard Approach (SA) method. This is a key difference between IRB and SA risk weights, with implications for Faroese banks’ lending practices.

Lower Risk Weights: Under the IRB method, corporate exposures are assigned lower risk weights compared to the SA method.
Impact on Lending: The more lenient risk weights under IRB may encourage Faroese banks to increase their lending activities, potentially leading to higher losses if not properly managed.

Impairment Charges and Losses: A Comparative Study

A comparison of impairment charges and losses in Faroese banks with Danish Systemically Important Financial Institutions (SIFIs) reveals that Faroese banks have posted higher losses on corporate loans. This highlights the importance of robust risk assessment methodologies and effective credit management practices.

Higher Losses: Faroese banks have reported higher losses on corporate loans compared to their Danish counterparts.
Risk Management Implications: The findings underscore the need for Faroese banks to strengthen their risk management practices, including more accurate credit assessments and better loan monitoring.

Capital Requirements and Lending: A Resilience Perspective

A well-capitalized institution is more resilient to losses and may even attract lower interest rates on its debt. This highlights the importance of maintaining a strong capital base in relation to lending activities.

Resilience: A well-capitalized bank is better equipped to absorb losses and maintain its lending capacity.
Lending Rates: Lower interest rates on debt can be an added benefit of a robust capital position.

Adjusting to Higher Capital Requirements

Banks can adjust to higher capital requirements by increasing their capital base, reducing risk-weighted assets, or reducing excess capital adequacy. Each approach has its implications for lending activities and overall risk management practices.

Increasing Capital Base: This involves raising additional equity funding to meet the increased capital requirements.
Reducing Risk-Weighted Assets: Banks can reduce their risk-weighted assets by selling off high-risk loans or investments, which can help meet the capital requirement without affecting lending activities.
Redistributing Excess Capital Adequacy: If a bank has excess capital adequacy, it can use this to meet the increased capital requirements rather than raising additional equity funding.

Excess Capital Adequacy in Faroese Banks

An analysis of the capital buffer requirements and excess capital adequacy of four Faroese banks shows that they have been able to meet the phased-in buffer requirements without a decline in lending. This indicates a positive trend in their risk management practices and financial resilience.

Meeting Buffer Requirements: The Faroese banks have successfully met the phased-in buffer requirements.
No Decline in Lending: Despite meeting the increased capital requirements, there has been no decline in lending activities, indicating robust risk management practices.