The Final Basel III Standard and the Danish Mortgage Sector: Impact on Danish mortgage banks and customers
The Final Basel III Standard and the Danish Mortgage Sector: Impact on Danish mortgage banks and customers
The Final Basel III Standard from December 2017 sets out revised international standards for banking regulation. The European Commission has recently published a proposal, outlining how the reform could be implemented in a European context. Here, the concept of an output floor is introduced, impacting the minimum level of capital that banks are required to hold for each type of asset. The motivation behind this is to create a backstop for excessively low modelled capital requirements.
Implementing the output floor according to the proposal will de facto entail a significant increase in capital requirements for low-risk assets, such as the Danish mortgage portfolio. Further, banks bound by the output floor will lose the risk sensitivity of their capital requirements as underlying risks of assets are no longer reflected.
If the reform is implemented according to the EU Commissions proposal, we find that:
The Danish mortgage portfolio will experience an increase in capital requirements of 36% on average.
This corresponds to banks having to raise additional CET1 capital of DKK 24-38 bn, depending on the extent to which group capital buffers on top of requirements are fully replenished.
In time, this will translate into higher borrowing costs for end-customers as capital is a more expensive source of funding (compared to debt). We estimate that annual borrowing costs for Danish mortgage customers will increase by some DKK 3.5 bn.
Consequently, we expect the investment activity in the Danish economy will decline, reducing productivity and GDP. We assess that the Danish GDP will permanently be reduced by 0.25% corresponding to DKK 6 bn.
Making the temporary exemptions permanent, i.e., the application of lower RW’s to the residential real estate portfolio could neutralise the effect from the output floor, resulting in much smaller increases in capital requirements for countries with low-risk portfolios like Denmark, thereby leading to a uniform impact across Europe.
The study has been commissioned by Finance Denmark.
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