Danish banks face tough times

Tuesday, January 06, 2009

The international financial crisis has affected the Danish banking sector adversely, the Danmarks National Bank said Monday. Banks were faced with the prospect of reducing their balance sheets.Currently, government guarantee for the banks' unsecured claims had facilitated access to liquidity. However, banks could face difficulties in obtaining finance given the present negative financial results of banks.

After the international financial crisis escalated in September and October, it was clear that extraordinary measures were warranted to prevent a collapse of both the financial system as well as of individual banks. The EU and the U.S.A. implemented bank rescue packages, which had stopped the intensification of the crisis. Danish banks, buffeted by the crisis have seen their earnings drop while future prospects are bleak. Banks face lower earnings and tight liquidity conditions, while some banks have opted for mergers to protect themselves. Lending has continued to grow robustly high while the rate of growth has started to decline. This trend is likely to deepen as smaller banks curtail lending. Yet, lending growth continues to outstrip deposit growth, the Danmark National Bank pointed out. Danish banks have on the average lent nine times their capital in recent months, compared to the historical average of seven times their capital. Together with falling equity and housing prices this would induce banks to tighten lending policies, the Danmark National Bank said. Credit losses at Danish banks, while currently low was expected increase in 2009.

There were three stress scenarios, the Danmark National bank observed. In the first a deep international recession would dampen demand for Danish products. In the second, the Danish economy would undergo a credit crunch, leaving even credit worthy borrowers unable to obtain loans. The third scenario combines the above two. In such circumstances, the government would be well advised to mull a capital injection program similar to the program implemented in America and Europe.

A capital injection of approximately 70 billion króna to the banking sector would enable the financial institutions to withstand severe economic shocks, the Danmark National Bank said.