Covered Bonds are the Answer to Growth and Jobs in the EU

6 April 2016

By Ane Arnth Jensen, Managing Director, Association of Danish Mortgage Banks

On the 14th of April 2016, Copenhagen will host the 23rd European Covered Bond Council (ECBC) Plenary Meeting. We very much look forward to hosting the meeting and anticipate a day with many interesting presentations and debates.

Denmark is in many ways the land of covered bonds. For more than 200 years, the Danish mortgage model, which is entirely based on covered bonds as a source of funding, has provided homeowners and businesses with affordable and stable financing. Our model provides for some of the lowest loan rates in all of Europe. And it is very resilient. Throughout the financial crisis, loan losses were low and loan volumes even rose. This was also the case in other EU countries where covered bonds play a significant role.

“Denmark is in many ways the land of covered bonds. The Danish mortgage model is entirely based on covered bonds as source of funding.”

The Danish mortgage model holds a special place in the Danish economy. Total lending accounts for more than 130% of GDP. 70% of total lending in Denmark constitutes mortgage lending from the Danish specialised mortgage banks. And 50% of the financing requirement of Danish businesses is covered by mortgage loans. Not least small and medium-sized enterprises benefit from the affordable and stable financing provided by the Danish mortgage sector. In other words, covered bonds are a fundamental prerequisite for growth and employment in Denmark.

Covered bonds and their significance as a funding source are also on the European Commission’s agenda. We find it useful that the Commission has set out to determine whether or not EU-wide covered bond regulation may support and foster growth and employment in the EU. A European approach building on the basic principles of sound mortgage regimes may raise international investors’ awareness of the European covered bond tradition. However, it is no less imperative that covered bonds can be retained as an extremely safe and stable source of funding.

Despite the positive signals from the European Commission, European financial sector regulation still poses a big challenge for covered bonds.

European credit institutions have been faced with significant volumes of new regulation in recent years. Everyone is working to adapt to the new and stricter capital requirements, new liquidity rules, special rules for systemically important financial institutions, consumer protection requirements, national supervisory requirements and new measures from credit rating agencies. In the EU, homeowners and businesses are already feeling the impact of financial regulation on their loans. And there is more to come.

At European and international levels – in Basel (Basel Committee on Banking Supervision – BCBS), at the European Banking Authority (EBA) and at the European Central Bank (ECB) – a number of new regulatory instruments are currently being considered. These instruments may have a huge impact on mortgage lending and covered bonds and, thus, borrowers all over Europe.

I am specifically referring to the plans to introduce a capital floor on the level of capital to be held by universal banks and mortgage banks applying more advanced approaches to determine capital requirements (IRB banks and mortgage banks), regardless of how secure their lending is. A capital floor which will be determined based on the revised standardised approach.

In Denmark, as in several other European countries, real estate financing by IRB banks and specialised mortgage banks plays an important role for the economy. The standardised approach is not reflective of the low mortgages loan losses and impairment rates in Denmark. As a result, the possible introduction of a permanent capital floor based on a “one-size-fits-all” standardised approach would disconnect the link between the risk of these loans and the required capital levels in our market, and thus distort the pricing of mortgage loans. This could have negative consequences for the overall economy in Europe and be a setback for the possibility of regaining sustainable growth. Furthermore, it could induce the credit institutions affected by disproportionate increases in capital requirements that do not reflect the risk of their current business model to engage in higher risk activities and relieve their balance sheet of low-risk loans. This, we believe, would not be conducive to financial stability.

The European Commission is working to create growth and employment in Europe, and to ensure a robust financial sector. This is a very important task which we fully support. We all benefit from financial stability and economic growth.

However, many of the measures contemplated appear to be working against this vision.

Therefore, I call upon the European Commission to refrain from adopting the Basel Committee’s plans blindly, but to take into consideration the unique European conditions. Let us join forces to promote a healthy financial sector for the benefit of growth and employment. And look to the good examples of secure, stable and inexpensive financing in Europe, where not least covered bonds play a vital role.

I look forward to discussing these and many other interesting and important topics at the next ECBC Plenary Meeting in Copenhagen in April 2016, and to welcoming you to the land of covered bonds.

Please note that any views or opinions expressed in this article are those of the authors and not necessarily those of the EMF-ECBC. This article does not constitute investment advice.