Supervision of Banks in Denmark; Lacking or Just Adequate?

By Finn Overgaard, Partner, and Michael Camphausen, Senior Associate, PhD, LETT Law Firm

Michael-CamphausenOver the course of the summer, repeated reports in the Danish press have indicated that approximately one fifth of Danish banks (including commercial, savings and cooperative savings banks) subject to supervision orders by the Danish Financial Supervisory Authority (the DFSA) have apparently not been recipients of an inspection visit from the DFSA for over three years.

These reports prompted critical comment from legislators and the media in Denmark. A perception that the DFSA was failing in the performance of its duties, and that the supervision of banks in Denmark was woefully inadequate, quickly asserted itself in the public consciousness. According to critics, the obvious implication of this inadequate supervision would be that a bank could be in dire financial straits, perhaps even heading for collapse, without the public, or relevant political and financial institutions, being aware of this state of distress; the financial crisis, and recent shortcomings in the Danish financial services sector further were also alleged to be signs that a bank’s own accounts could not be trusted, which highlights the need for regular inspection visits to the banks.

However, an examination of the list of banks that have, according to the Danish press, not been paid any inspection visits during over the past three years reveals a list dominated by a number of small banks – including especially small local savings and cooperative savings banks – a far cry from dominant national banks. Furthermore, the list does not allow for recent developments, such as key mergers, or even newly inspected banks that are yet to receive the findings of their inspection report from the DFSA.

Risk-based supervision
Danish financial supervision of banks is a so-called ‘risk-based supervision’. This means that the DFSA focuses partly on intensively monitoring the most risky activities carried out by banks, and partly on monitoring risky banks to a greater degree than banks that have not assumed such major risks. The principle of risk-based supervision is codified in the Danish Financial Business Act, which stipulates that “organisation of supervision activities shall take materiality into consideration so that the supervision effort is proportionate to the potential risks or damage”.

In other words, the DFSA applies the greatest amount of resources to the banks that are most important in terms of financial stability in Denmark, and to the banks holding the highest risk profile. As a result, a number of less risky banks as well as the smaller banks will indeed find that the DFSA does not pay them regular inspection visits.

Moreover, according to the Financial Business Act, the DFSA is to review the solvency requirements for all banks whose so-called working capital exceeds DKK 250m (approximately EUR 33.5m) annually. In effect, this encompasses all medium-sized to large banks. Consequently, this constitutes regular supervision of the finances of the vast majority of banks even if the DFSA does not pay an actual inspection visit to the individual bank.

Finally, the overall financial supervision of banks consists not only of inspection visits and reviews of the solvency requirements of the individual banks. The DFSA also reviews the reports regularly submitted by individual banks to the DFSA, and may order the management of a bank to arrange for the preparation of additional reports detailing the financial position and prospects of the bank. Recent years have seen a general tightening of financial regulation in the wake of the 2008 crisis, and the requirements for the regular submissions by the banks have been tightened accordingly.

A political issue
Finn-OvergaardWhether to amend the current regulation of the supervision activities is a political issue. This would necessitate further resources to the DFSA, as any major altering of priorities within the present regulatory and political framework will hardly be possible. At least, that seems to be the opinion of both the DFSA and the responsible minister as expressed in brief comments on the above criticism levelled by the press.

However, it should be noted that the market may have other expectations of the frequency of the DFSA inspection visits and that several financial analysts have pointed out that the share price of a bank may also be influenced by, or even depend upon, the length of time elapsed since the most recent inspection visit.

A number of the banks that have not been paid any inspection visit during the last three years have actually stated that they are looking forward to such a visit, as these visits are of interest to investors as well as creditors. Essentially, healthy banks can often expect an increase in their share price as a result of a satisfactory DFSA inspection report, whereas unhealthy banks may face a drop in their share price as a result of an adverse inspection report. And, actually, some of the banks have stated that even an inspection report imposing a number of orders and risk information may, in relation to investors and creditors, be preferable to several years without an inspection report. Hence, they would prefer clarification in the short-term to long-term uncertainty.
This situation is quite a paradox, as banks have traditionally preferred the DFSA not to find any cause to pay an inspection visit and, if it did, preferred the inspection report to be flawless. But it highlights that, in the wake of the financial crisis which brought a large number of failed Danish banks, the market – at least in Denmark – appears to have a continuous agitation to be updated, and may be fragile in the face of any more or less justified uncertainty.

In this context, it is worth highlighting that the recent focus by the press on banks without inspection visits does not seem to have had any effect on the general perception of or attitude towards supervisory efforts in Denmark, and also seems to have entailed no further financial implications for banks or for Denmark as such.

More extensive supervisory powers
Generally, the overall supervisory efforts have intensified considerably in Denmark over the last few years. This is a result of the DFSA being equipped with an array of increasingly extensive supervisory and regulatory powers.
Compared to the financial services landscape pre-2008, far more discretionary and radical powers are available for ensuring financial stability, and preventing further bank failures. As a result, the supervisory role of the DFSA has changed, to the effect that the primary role played by the body is no longer to merely oversee compliance by banks and other financial undertakings with financial legislation. On the contrary, this now seems to be merely a secondary task, which may reflect a fundamental paradigm shift in relation to the traditional perception of the supervisory role. Instead the primary role of the DFSA is now to address the viability of the business model of the individual financial undertaking, a purpose expressly articulated in the Financial Business Act. Consequently, the primary raison d’etre of the DFSA is now to focus on elements related to the business and operation of banks, which were previously the exclusive province of the bank managements.

The actions by the DFSA based on these new and radical powers have led to a highly topical debate in the financial services sector and among Danish politicians as to whether, in wielding its new powers, the DFSA puts banks under far too close scrutiny, particularly in terms of their actual operation and management, resulting in the line between banking supervision on the one hand and bank management and bank operation on the other hand becoming more blurred and unpredictable.

Danish financial stability
It now appears expressly from the Financial Business Act that the DFSA is to organise its routine supervision activities with a view to promoting financial stability and confidence in financial undertakings and markets. The ultimate concern is thus financial stability in a broad macroeconomic sense and no longer only a concern for the individual bank and its depositors in a stricter economic sense.

Furthermore, the DFSA has been given the power to take measures against an individual bank at a far earlier stage than before. Previously, a bank had, in effect, to be in current financial distress (i.e. actually failing to comply with the solvency requirements), in order for the DFSA to be able to take the necessary measures. Today, the DFSA can take such measures at a far earlier stage, even if the bank in question is not in current distress, and not only in connection with inspection visits by DFSA representatives, but as a result of the general supervision and examination of banks, including as a result of the DFSA review of the regular submissions made by the banks.

Special requirements for publication
Finally, it should be noted that according to the Financial Business Act, a Danish bank is obligated to make publicly accessible the findings contained within the DFSA’s supervisory assessment, including information usually restricted from public view in other Western financial sectors, such as orders imposed and risk potential. Moreover, the DFSA reserves the right to publish such information prior to a bank doing so if they believe these findings represent actionable dangers or weaknesses.

In addition, banks in Denmark are under a special duty to publish their individual solvency requirements.
And so, in this way too, the public are regularly informed of the state of health of Danish banks.

Lacking or adequate supervision?
To sum up, it may be argued that concerns over the perceived lack of supervision in the Danish financial sector amounts to little more than a transient panic, cultivated by a media and public apprehensive of the activities of the banking industry. In truth, supervisory measures currently in operation in the Danish financial sector have intensified considerably since the financial crash of 2008. Supervision of Danish banks is, by Eurozone standards, proactive and efficient, and banks operating in Denmark are subject to internal policies, and a legal environment, far more stringent and watchful than those in effect in many of their counterparts in Western Europe. In the least, a lack of official inspection visits is in no way tantamount to a systemic lack of supervision on the part of the DFSA.