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Faroese Banks’ Risk Weights and Capital Requirements: A Comparative Analysis
A new report has shed light on the risk weights and capital requirements of Faroese banks, providing a unique insight into their financial stability.
Average Risk Weight Comparison
The analysis reveals that Faroese banks have a lower average risk weight compared to medium-sized Danish banks. This is attributed to their higher share of exposures secured by mortgages on real estate, which are associated with relatively low risk weights. This contributes to their slightly lower total average risk weight compared to their Danish counterparts.
Large Danish Banks’ Risk Weights
In contrast, large Danish banks have a larger share of loans to corporates, which are subject to significantly lower IRB risk weights. These risk weights are calculated based on individual circumstances and loss history, making them more nuanced than SA risk weights.
Higher Losses and Impairment Charges
The report also highlights that Faroese banks have posted higher losses and impairment charges compared to Danish SIFIs (Systemically Important Financial Institutions) with IRB authorization since 1996. This suggests that if given IRB permission, Faroese banks’ risk weights would not be as low as those of Danish SIFIs.
Capital Requirements and Lending
The study also examines the relationship between capital requirements and lending. It argues that higher capital requirements do not necessarily reduce lending, but rather increase the resilience of banks to losses on assets. This is because higher equity allows banks to absorb higher losses before creditors are affected, reducing the risk of creditors suffering losses.
Adjusting to Higher Capital Requirements
Furthermore, the report discusses how banks can adjust to higher capital requirements, including:
- Increasing their capital through retained earnings or new capital
- Reducing risk-weighted assets by adjusting their asset mix
- Reducing excess capital adequacy
Meeting Phased-In Buffer Requirements
The Faroese banking system has been able to meet phased-in buffer requirements without a decline in lending. The country’s banks have an excess capital adequacy of around 3-4%, which is higher than the minimum requirements.
SIFI Requirements
In related news, the report highlights the importance of SIFI (Systemically Important Financial Institution) requirements in reducing the risk of financial instability. SIFIs are subject to additional requirements to ensure their stability and mitigate the impact of their potential failure on the economy.
Conclusion
The report concludes that a comprehensive understanding of risk weights and capital requirements is crucial for ensuring the stability of the financial system, particularly in small economies like the Faroe Islands.