Danes move in to burn bondholders where Ireland fears to tread

 

EUROPEAN DIARY: While Denmark’s burden sharing policy has been honed, senior creditors are still liable to take hit

TWICE IN the past year Danish authorities have done something the Irish dare not do: impose losses on senior creditors in a failing bank. They may yet do it again, although new measures have been put in place in a bid to avert that prospect.

As Dublin prepares to repay another €1.25 billion to senior bondholders in Anglo Irish Bank on January 25th, the Danish tale is resonant to say the least.

The world did not end when Copenhagen scorched the bondholders, but some personal customers, municipalities and companies did lose large deposits.

If the story of Denmark’s banking crisis is all too familiar, the circumstances are markedly different from those in Ireland. Firstly, the country is not in the single currency, so the European Central Bank is not the prime player that it is in the euro zone.

Therefore, the ECB’s refusal to countenance any burden-sharing with senior creditors does not hold sway.

In addition, the separation of Danish banks from euro zone lenders means contagion risk is reduced. This is important, as the ECB fears any senior bond losses in Ireland would puncture confidence in the entire stock of weakened bank debt in the euro zone.

Issues of scale also arise. The loans in the Danish banking system were not as large as in Ireland and the losses incurred in its property crash were not as great. Furthermore, a scattered banking sector with more than 120 lending institutions means some of them are tiny. This facilitated the development of different policies for small banks and their bigger, systemically-important brethren.

Predictably, the affair has its roots in blithe lending and blinkered borrowing. When the dancing stopped, a 20 per cent property market collapse and large defaults on agricultural loans led the state to prop up banks. By the end of 2010 no fewer than 10 lenders had been rescued.

The government changed course that year, introducing a new policy designed to minimise the exposure of taxpayers when a blanket guarantee was unwound.

Crucial here was the decision to allow non-systemic banks to fail if there was no reasonable prospect of retrieving their business.

“We do not have a healthy banking sector in the long run if we always bail out banks,” said a senior Danish official who is deeply involved in banking policy.

This initiative was put to the test last February when the management was replaced at a lender called Amagerbanken, which had about 2 per cent of the national market. Amagerbanken had already received a couple of cash infusions but the new bosses uncovered further losses, leading to a requirement for more aid. The government baulked, deciding instead to let it go.

Amagerbanken’s private shareholders had already been wiped out. The next move would see other investors – including senior bondholders and depositors, who have an equal standing in Danish law – incur a loss.

The first estimate was that they would lose about 44 per cent of their receivables when the bank was wound up. In the later analysis they lost a little over 15 per cent, with the possibility of a further clawback. For depositors, the loss was applied to any sum in excess of the equivalent of €100,000 protected under statute.

Other banks did not welcome this development, arguing that it would freeze them out of inter-bank lending markets. In the government, however, the argument was made that the weakest among them did not have access to private funding anyway.

“It’s hard to see that there was any significant change,” the Danish official argues.

This is at odds with views in the financial sector. According to Moody’s credit rating agency, which downgraded some Danish lenders twice last year, funding issues have increased.

The official said the government was quite surprised by the amount of international attention drawn to the Amagerbanken case. Still, it followed suit with a similar move in June by allowing another, smaller lender – Fjordbank Mors – to fail.

Shares in other banks came under pressure, however, and both the government and the Danish central bank issued statements reassuring investors that Danish banks were safe.

Next, the government honed the policy. Concerned that Denmark might be considered at a vulnerable time to be an international outlier, it introduced a new provision designed to make it more attractive for a stable bank to take over a stricken bank.

Simply put, the acquiring bank would receive a kind of a “dowry” from the state for its trouble. The government still reserved the right to make a bank fail, but this mechanism was deployed in October to prevent the failure another small lender, Max Bank.

At the same time, the government has signalled implicit protection for systemic banks but has not named them. With a dozen or more weakened banks still under threat in the crisis, further tests lie ahead.

Whether Denmark takes the torch to bondholders again remains to be seen.