Denmark is adjudged compliant with 19 of the 30 principles and sub-principles that make up the Basel Core Principles (BCPs) for Effective Banking Supervision and largely compliant with the remaining 11 BCPs by a 2007 detailed assessment by the International Monetary Fund (IMF). The areas of less than full compliance include the independence of the supervisor, licensing and investment criteria, connected lending, internal control and audit, money laundering, bank management contact, validation of supervisory information, remedial measures, and supervision of foreign branches in the country. Recommendations pertaining to the areas of less than full compliance include formalizing provisions in the Financial Business Act pertaining to the Danish Financial Supervisory Authority's (DFSA) statutory status, fit and proper testing of key management positions in banks, and prior approval for investments in non-financial companies. The detailed assessment also recommends that the DFSA be provided its own budget, have more discretion in identifying connected lending, strengthen its risk based supervision, enhance on-site inspections, maintain greater contact with bank management, and strengthen global consolidated supervision.

General Overview

The detailed FSAP assessment conducted for Denmark in 2005 and published in 2007 concludes that Denmark is compliant with 19 of the 30 principles and sub-principles that make up the Basel Core Principles (BCPs) for Effective Banking Supervision and largely compliant with the remaining 11 BCPs. The areas of less than full compliance include the independence of the supervisor, licensing and investment criteria, connected lending, internal control and audit, money laundering, bank management contact, validation of supervisory information, remedial measures, and supervision of foreign branches in the country.

The Danish Financial Supervisory Authority (DFSA) shares the responsibility for financial sector stability with the Danish National Bank (DNB). The DFSA supervises financial institutions and investment business, and shares the responsibility for payment systems with the DNB. The DFSA's supervisory powers and responsibility are laid out in the Financial Business Act of 2006 whereas the DNB receives its oversight mandate from the DNB Law of 1936. The two institutions coordinate their supervisory activities and avoid duplication with the help of a coordination committee on financial stability, chaired by the Ministry of Economic and Business Affairs' (OEM) permanent secretary. Further, a memorandum of understanding (MoU) has also been signed in May 2005 between the DFSA, DNB, OEM, and the Ministry of Finance (MoF) to ensure a pragmatic approach to coordinated supervision. The DNB is accountable to the OEM but is also under the jurisdiction of independent councils established under the Financial Business Act and comprised of independent experts and industry representatives; viz., the Financial Business Council covering financial companies and holding companies, the Danish Securities Council covering securities regulation, and the Pension Market Council covering pension funds. Therefore, although the DFSA has the power to impose sanctions for violations of its authority, the councils decide matters of significance to a supervised institution. The Councils were created with the objective of taking decisions and supervising institutions independent of the OEM and therefore without political interference. The Minister of Economic and Business Affairs is not empowered to issue instructions to the DFSA except on certain legislative and regulatory matters but may seek its consideration on certain issues. The DFSA can overstep its supervisory authority with prior additional mandate obtained from the OEM. It also must inform the OEM on matters of great social and political importance.

The entities supervised by the DFSA include financial holding companies, commercial, savings cooperative, and mortgage credit banks, insurance companies and brokers, pension funds, mutual funds and securities firms. The DFSA further monitors developments in the financial sector and practices risk-based supervision. The DFSA's regulatory activities include drafting financial sector laws and regulations, and European Union (EU) level coordination. The agency maintains transparency in its activities by publishing comprehensive annual reports, statistical information, and average performance indicators, and facilitating peer reviews and external audits. The DFSA has adequately trained and qualified supervisory staff and its funding is tied to the federal budget, although the costs are borne by the supervised entities. The assessment observes that recent factors may lead to resource driven demands on the DFSA and therefore calls for increase in its funding. For instance, the implementation of Basel II and International Financial Reporting Standards (IFRS) have allowed the banks to reduce their capital cushions and this will necessitate closer monitoring of their reserves and provisioning. Also, the recently enacted anti money laundering/combating the financing of terrorism (AML/CFT) legislation stipulates greater on-site oversight in this area. In general, too, on-site inspections by the DFSA of its supervised entities need to be enhanced in frequency and quality.

The IMF detailed assessment finds that the preconditions for effective supervision are "largely in place" (p. 9). Denmark has been an EU member since 1973, and as such has adopted and implemented all EU Directives on financial regulations in its laws and practice. The country has reliable and effective payment systems, corporate governance and disclosure regimes, external audit function, anti-corruption safeguards, and accounting and auditing practices. Contracts are also easily enforceable. The assessment notes that the alignment of Danish laws with international/EU standards on capital adequacy, provisioning, and accounting have led to less strict requirements on supervised banks. Denmark has a deposit insurance system, the Guarantee Fund for Depositors and Investors (DGF), which covers deposits of up to Danish Krone (DKK) 300,000 per depositor and requires a mandatory membership of all credit institutions. Appointments to the board of the DGF are made by the Minister of Economic and Business Affairs and it is supervised by the DFSA. Foreign banks are also eligible to buy insurance in the DGF if their national coverage falls short of the Danish system.

Providing an overview of the Danish financial sector, the 2007 detailed assessment notes that it is "deep...and sophisticated" (p. 5) with total assets reaching almost 500 percent of the national GDP and offering some unique financial instruments, such as mortgage bonds. The deregulation of the financial sector in the 1970-1980s has resulted in an expansion of the sector's business lines, mergers and group formations, establishment of financial holding companies foraying into financial activities that are not possible within a strictly banking function, and even breakups. There are many commercial banks in the market (a statistical report on the DFSA website mentions that as of 2007, there are 147 commercial banks); however, the two largest banking groups - Den Danske Bank and Nordea Danmark - account for more than 50 percent of the commercial bank lending and the five largest banking groups account for about 80 percent of total loans (71 percent if foreign branches are excluded). The banking sector is, therefore, concentrated. Commercial banks are profitable and have adequate capital cushions. Mortgage banks (totaling 8 in 2007 as the DFSA statistical report mentions), are also large and profitable, though less so than the commercial banks. Their assets total 134 percent of the country's GDP and their profits are tempered by legal requirements to mitigate risks. These banks run under a special legislation that allows them to finance their mortgages with collateralized mortgage bonds. Two banks dominate the mortgage financing sector with more than 70 percent of new gross lending - Nykredit and Realkredit Danmark, which is part of Den Danske, the largest Danish banking group.

The Principles

1. (1) Clear responsibilities and objectives for each supervisory agency.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The assessment acknowledges that Danish tradition has been to create a public authority by government decision rather than through an act of law. It, nevertheless, feels that a clear legislative provision establishing the DFSA would be desirable in terms of according clarity in the autonomy and accountability of the DFSA and in making its organization and supervisory functions more transparent.

1.(2) Operational independence and adequate resources.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. The assessment finds no evidence of government or industry interference in the functioning of the DFSA. However, given that the DFSA is under the OEM, its independence and decision-making cannot escape being overruled or ignored. The assessment, therefore, suggests to root the DFSA's authority and independence in a statutory provision. Further, as the assessment notes, the DFSA does not have formal budgetary independence since its budget is a part of the government budget. This may have implications on its operational flexibility. Staffing resources appear adequate and commensurate with the current levels of supervisory responsibilities; however, they may need to be augmented if the DFSA undertakes additional responsibilities such as on-site inspections relating to the implementation of Basel II and the new money laundering law.

The Danish authorities responded by accepting the suggestion of providing a statutory basis to the DFSA's authority and autonomy and of separating its budget from the government budget. However, they do assert that the end should be to make available adequate funds to the DFSA rather than revamp the budgetary procedure. Also, the budget should be more clearly delineated to provide a transparent overview as to how resources for each separate supervisory activity is allocated and used. As for the last recommendation pertaining to increased resources for additional responsibilities, the authorities state that they have indeed been provided in the wake of the EU's Capital Requirement Directive and the Third Money-Laundering Directive. Further, the DFSA is building up its stress-testing capacity and that would require further increase in resources.

1.(3) A suitable legal framework for authorization and ongoing supervision.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The Financial Business Act provides the legal framework under which the DFSA is authorized to grant and withdraw banking licenses; authorize foreign banks to open branches and subsidiaries in Denmark, issue executive orders, circulars, and guidelines, provide recommendations and explanations, and demand information from supervised entities as and when deemed necessary.

1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. As the assessment elaborates, "Section 344 of the FBA [Financial Business Act] enables the supervisor to address compliance with laws and the safety and soundness of the banks under its supervision...[and] Section 350/1 of the FBA enables the DFSA to take and/or requires a bank to take supervisory measures" (p. 17). Further, the DFSA has a range of remedial measures and sanctions to take corrective action.

1.(5) Legal protection for supervisors.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Action taken in good faith by any employee in any organization is granted legal protection under the Act on Liability Claims. In practice, too, the supervisory staff of the DFSA is not held personally liable for performing supervisory duties for the DFSA.

1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Since the DFSA is "an integrated supervisory agency...there is no need for special agreements on how to share information between supervisors of different sectors" (p. 17). Nevertheless, it does cooperate regularly with the DNB and also has a MoU with the latter in the area of financial surveillance. Further, the DFSA has MoUs with foreign regulators and is part of the information exchange and cooperation system of the EU.

2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The Financial Business Act clearly defines the term bank.

3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. EU directives specify most of the rules and regulations on licensing criteria. However, the law only indirectly requires or deals with the assessment of the suitability of the beneficial ownership, the transparency of ownership structure and the sources of initial capital, and may require greater clarity. Further, the fit and proper testing only covers the Board of Directors and the Board of Managers. The assessment calls for a more comprehensive testing covering other key management officials. The assessment also finds that a foreign bank setting up a branch in Denmark is not required to produce a statement of "no objection" from its home supervisor. The Danish authorities respond to the fit and proper testing recommendation by asserting that the costs of such testing to both the supervised banks and the DFSA may exceed the benefits of such a measure.

4. Authority to review and reject transfer of ownership.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Nevertheless, the assessment recommends that the DFSA be granted the power under the Financial Business Act to take measures and corrective action to ensure a transparent ownership structure. The DFSA should also be obliged to consult with home supervisors before authorizing significant acquisitions by the foreign supervised entity.

5. Authority to review major acquisitions and investments.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. There are no criteria for assessing individual proposals for investment and the banks are not required under the Financial Business Act to obtain prior approval of the DFSA to invest in non-financial companies. The Danish authorities respond by stating that the DFSA indeed has several criteria for judging investment proposals and that BCP 5 does not explicitly require approval of the supervisory authority prior to investment in non-financial companies.

6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. A bank falling below its solvency requirement, as determined by the DFSA usually during an on-site inspection, can be mandated by the DFSA to take appropriate action as spelled out in the Financial Business Act to reach its minimum requirement. However, the DFSA is advised to issue guidelines clarifying such remedial actions to be taken by banks. The 2007 Global Survey report by the Institute of International Bankers adds that in the event that the bank fails to take the necessary measures specified by the DFSA in the stipulated time period, the DFSA may withdraw its license. The capital base, as stipulated in the Financial Business Act, may not fall below 8 percent of the risk-weighted items and €5 million. However, the DFSA may lay down requirements more than the above base on the basis of the bank's risk profile.

7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Under the Financial Business Act, the Boards of Directors of banks are responsible for preparing written guidelines on the significant activities of the bank. They are also required to review their credit policies annually. The DFSA conducts on-site inspections during which it "evaluates a bank's credit policy, its procedures for granting credit, the organizational structure, duties and responsibilities of those involved, principles for valuing collateral, arrangements for monitoring the credit portfolio, and the principles for recognizing the impairment of credits and the making of provisions and writing-off of bad debts" (pp. 25-26).

8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Mechanical rules for loan classification are not set out by the DFSA and banks are prescribed to undergo tests laid out in International Accounting Standard (IAS) 39. Traditionally, banks are also mandated to develop their own internal risk classification. These two measures, per the DFSA, "give a sufficient measurement of the banks' asset quality" (p. 27) and as such stipulating mechanical rules of classification would not "add significant value to the supervision of the banks' asset quality" (p. 27). Moreover, the DFSA obliges banks to report loans that have missed their scheduled payments to safeguard against subjective tests of loan impairment.

9. Prudential limits and management information system on concentration of exposure.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The Financial Business Act requires banks to report their large exposures on a quarterly basis and also report immediately any violations of their large exposure limits. However, the DFSA frequently does not conduct annual on-site inspections of banks and therefore feels that verification of financial reporting through external auditors may not be adequate in terms of detecting large concentrations.

10. Arm's length rule and monitoring for connected lending.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. Although the law specifies cases of connected lending, the DFSA has no power to identify connected lending in cases beyond those specified in the law. The board of the bank must discuss and approve all connected lending. However, when lending within a group if a bank is part of a larger financial entity, connected lending may increase to almost 100 percent of the base capital. The assessment, therefore, suggest that appropriate power be granted to the DFSA to identify such instances of intra-group connected lending and require collateralization of such exposures. The Danish authorities, however, counter by stating that they feel that the country fulfills the criteria for BCP 10, and that there are adequate limits to connected lending specified in the Financial Business Act. Additional powers to the DFSA are not considered necessary by the Danish authorities.

11. Policies and procedures for country risk and transfer risk.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The DFSA reviews exposures of banks to country risk during on-site inspections and can also require ad hoc reporting on such exposures. However, it does not require routine reporting of such risks on a country-by-country basis by banks.

12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. However, the DFSA has limited resources available to monitor this area. The assessment notes, nevertheless, that most banks are not taking sophisticated market risk.

13. Comprehensive risk management processes.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. The DFSA requires banks to have adequate policies in place with regard to internal audit, procedures to combat fraud, business recovery and other elements of operational risk as well as on liquidity. However, the DFSA does not require banks to regularly monitor or report on changes in net funding requirement, stress testing, and contingency planning for worst case scenarios, though this measure was adopted by the DFSA in previous periods of liquidity strains. The Danish authorities respond by stating that starting 2007, banks will cover operational risks through capital reserves, and liquidity risk has historically been limited. Further, the DFSA does plan to "enhance its liquidity supervision, in particular with respect to stress testing and contingency planning, as part of its implementation of Basel II" (IMF 2007a, p. 44).

14. Adequate internal controls.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. First, the internal control requirements, as specified in the Financial Business Act are not expanded upon or provided guidance for in DFSA Guideline 9680. The assessment, therefore, calls for an executive order to fill this gap. Second, the DFSA does not have the power to evaluate the performance of individual board members or remove them, although it may cancel a license if the Board is found to be delinquent in the discharge of its functions. Third, internal auditors and other officials responsible for internal control and risk management as also members of the management apart from the members of the board of management are not subject to the "fit and proper" criteria. These gaps are advised to be filled by the detailed assessment.

15. Strict "know-your-customer" rules and high ethical and professional standards.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. The Danish Bankers Association guidelines on Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) have been given statutory basis by a 2006 law, which also puts into legislation the 2003 revisions to the Financial Action Task Force (FATF) recommendations. However, as the assessment notes, on-site inspections, especially those related to AML/CFT and for smaller banks, are not frequent.

16. Effective supervisory system consisting of on-site and off-site supervision.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The DFSA's "on-site and off-site work are well integrated" (p. 33) and it makes good use of internal and external audits, but relies most heavily on on-site inspections. The DFSA further assures that its resources are adequate for such inspections, although the National Audit Office (NAO) recently criticized it for inadequate resources that are also not directed towards high risk institutions. The DFSA is a small agency and sends modest inspection teams to the supervised banks. Smaller banks and banks not deemed high risk are inspected only once in four years or even less frequently. The assessment, however, notes that the issue of resources will be addressed in the government's response to the NAO's criticisms.

17. Regular contact with bank management and understanding of bank's operations.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. The DFSA sets up regular meetings with the management of only the five largest banks and the low rated banks during their annual on-site inspections. Other banks do not undergo such frequent inspections and therefore contacts are less regular. The assessment does note that the frequency of such contacts will increase with the planned augmentation of supervisory staff resources to the DFSA. The Danish authorities justify the allocation of resources and their focus on risk-based supervision under which large and/or vulnerable banks are more frequently scrutinized and contacts with their management held on a more regular basis.

18. Analytical reports and statistical returns on solo and consolidated basis.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Further, the DFSA "has comprehensive powers under FBA Section 347 to obtain whatever information it needs from licensed institutions, including from branches of foreign banks" (p. 34).

19. Independent validation of supervisory information through on-site examination or external auditors.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. External auditors fill an important gap of information verification during the long intervals between on-site inspections. The DFSA corresponds with them frequently; however, it does not have a formal arrangement for annual meetings with them. Further, meetings with banks' internal auditors are also held not by their respective supervisory teams at the DFSA but by the DFSA's accounting department.

20. Ability to supervise on a consolidated basis.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Consolidated supervision on the domestic front is generally problem-free due to integrated supervision exercised by the DFSA. Further, as regards mortgage banks that either own, or are owned by, commercial banks, the Mortgage Credit and Investment Companies Division of the DFSA provides the expertise on consolidated supervision. With respect to global consolidated supervision, "the DFSA has entered into effective arrangements with other supervisory authorities in the region to ensure the consolidated supervision of the major banking groups operating in Denmark" (IMF 2007a, p. 35).

21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Further, "the DFSA has the power to specify accounting arrangements which, from 2005, must be consistent with IFRS [International Financial Reporting Standards], as required by EU regulations" (p. 35). However, some steps taken by Danish banks with respect to loan-loss provisioning are found by the assessment to go against the stipulations of IAS 39. It however notes that the DFSA "is contemplating using its powers to raise capital requirements for individual banks" (p. 36) to prevent this practice.

22. Adequate supervisory measures to ensure timely corrective action.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. Despite the absence of legal "prompt corrective action" powers with the DFSA, in practice, the assessment does find adequate measures for the DFSA to take action when required. For instance, changes to the sanction framework have enabled the DFSA to take action faster than under the standard "prompt corrective action" framework. Further, the DFSA cannot remove key management officials since they do not belong to the board of directors; however, it does have the power to require the Board to take remedial action against the errant officers. Similarly, although the DFSA cannot disallow dividend payments, it can do so under circumstances where there is clear evidence that they are detrimental to the depositors' interests. Overall, the DFSA is obliged to the government to take prompt action to deal with problems and process such cases within set time limits.

23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. Under the Financial Business Act, the DFSA is authorized to conduct global consolidated supervision.

24. International exchange of information with other supervisors.

FC

Denmark is compliant with this principle, notes the 2007 detailed assessment by the IMF. The assessment, nevertheless, suggests that the DFSA should have powers under the Financial Business Act to prohibit banks or their affiliates from setting up branches in countries where supervision is inadequate due to secrecy laws or other barriers to information. Also, the Act must have a reciprocity clause vis-à-vis other country supervisors.

25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

CP

Denmark is largely compliant with this principle, per the 2007 detailed assessment by the IMF. The assessment notes certain shortcomings in the legal framework afforded by the Financial Business Act pertaining to home-host supervision that facilitates effective consolidated supervision. In particular, the DFSA does not require a no-objection certificate from the home supervisor before licensing a foreign bank to open a branch in Denmark. It also does not ensure that the home supervisor practices consolidated global supervision. However, this shortcoming, the assessment observes, does not adversely impact the DFSA's supervision since most foreign banks operating in Denmark belong to the EU/European Economic Area (EEA) area. Similarly, although the Financial Business Act does not provide the home supervisor the right of access to Danish branches and subsidiaries, the DFSA has never disallowed such on-site visits from home supervisors. Nevertheless, the DFSA does not communicate with home supervisors on remedial action taken against their supervised banks unless there is a MoU concluded with the pertinent country. The Danish authorities respond by stating that the DFSA cooperates with other pan-European agencies in communicating with or evaluating home supervisors that do not belong to the EU/EEA area.