FAROESE BANKS’ RISK WEIGHTS AND CAPITAL REQUIREMENTS: A COMPARISON WITH DANISH BANKS

Risk Weights: A Comparison with Danish Banks

According to recent data, the average risk weight of Faroese banks is slightly lower than that of medium-sized Danish banks. This is attributed to the high share of exposures secured by mortgages on real estate, which have a relatively low risk weight.

• Breakdown of risk weights:
  • Large Danish banks have a larger share of loans to corporates, which are subject to significantly lower risk weights using the Internal Ratings-Based (IRB) approach.
  • Faroese banks’ higher losses and impairment charges compared to Danish SIFIs with IRB authorisation suggest that their risk weights would not be as low if they were given IRB permission.

Capital Requirements and Lending

Capital requirements are designed to introduce minimum criteria for the share of equity funding, which can reduce lending and increase lending rates. However, empirical evidence suggests that well-capitalised institutions are met with lower required returns on debt and equity, making them more resilient to losses.

• Banks can adjust to higher capital requirements by:
  • Increasing their capital
  • Reducing risk-weighted assets
  • Reducing excess capital adequacy

The Faroese banks have shown no signs of declining lending despite increased buffer requirements, suggesting they are able to meet these demands.

Excess Capital Adequacy in Faroese Banks

The Faroese banks’ primary funding sources are deposits and equity, with 45% of bank deposits not covered by the deposit guarantee. This sensitivity to risk is expected.

• All Faroese banks will be able to meet phased-in buffer requirements and a systemic risk buffer of 3% from January 2020.
• Table 4 provides an overview of capital buffer requirements and excess capital adequacy for the four Faroese banks.

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. Designated SIFIs must comply with a SIFI capital buffer requirement, among other things.

In conclusion, while Faroese banks’ average risk weights may be lower than those of Danish banks, their higher losses and impairment charges suggest that their risk weights would not be as low if they were given IRB permission. The banks have shown no signs of declining lending despite increased buffer requirements, indicating their ability to meet these demands.