Denmark’s central bank proposes reforms to mortgage credit market

The National Bank of Denmark is in favour of introducing regulatory changes to the financial system to enhance competition in the market for mortgage credit.

The central bank identifies that “the mortgage banks’ direct competition with each other is only limited”. As such, it is advocating a series of reforms to foster competition while safeguarding the stability of the financial system.

The regulator points out that the reforms must ensure institutions’ capital adequacy is “robust and appropriate; that the institutions have stable funding; and that they may ultimately be resolved without considerable negative consequences for financial stability and the economy”.

Denmark’s central bank emphasises the importance of establishing that mortgage banks, as well other financial institutions, have a sufficient volume of eligible liabilities.

This would accomplish two objectives, according to the regulator. Firstly, it would increase competition and transparency in the mortgage market by levelling the playing field between mortgage banks, other Danish banks and international institutions. Secondly, in the case of unviability, it would allow the resolution authority to write down the claims of shareholders and creditors or convert them to equity.

“This would ensure that there are sufficient funds for the bank to be recapitalised and for functions that are critical to society to continue, without affecting the mortgage bonds,” the central bank says.

Without imposing a minimum volume of eligible liabilities and resorting to bail-ins, the bank considers the reform would fail to solve the “too-big-to-fail” problem.

“The government would, instead, feel compelled to support a distressed mortgage bank,” the central bank says. “An implicit government guarantee of this kind also distorts competition since it gives mortgage loans an advantage, both over bank loans and over potential competition from abroad.”

Avoiding a highly concentrated market is important because when a big mortgage lender runs into trouble markets may start questioning its robustness, which could “lead to a sizeable decline in the total credit supply”, the bank says. This is especially worrying, given that Danish mortgage banks share very similar business models and assume similar risks.