Denmark Guarantee Scheme

The international financial system had been experiencing challenges for almost a year before the crisis truly manifested in Denmark during the Summer of 2008 with the sudden demise of Roskilde Bank—Denmark’s eighth largest bank with a balance sheet of almost DKK 43 billion (€5.8 billion)^FNDKK 43 billion is approximately €5.76 billion according to the average Jun. 2008 through Aug. 2008 exchange rate (€1 = DKK 7.4614) and approximately 105,000 customers. Roskilde’s collapse was symptomatic of a more systemic weakness in Denmark’s banking sector, namely an increased dependence on short-term market financing that had reshaped the industry in recent years. This weakness was challenged in the fall of 2008 when foreign credit institutions and money market funds started to doubt the health and creditworthiness of Danish financial institutions. In the wake of Lehman Brothers' bankruptcy in September 2008, Danish financial institutions were even more severely cut off from access to liquidity on account of the international crisis of confidence between financial institutions.

As more Danish banks became distressed in the fall of 2008, the government determined that it was necessary to intervene in the banking sector through actions such as taking over and winding up distressed banks, giving guarantees to the sector, and providing capital injections and liquidity support. Throughout the financial crisis and its aftermath, Danish authorities implemented these various measures to help safeguard financial stability in consecutive stages now known as the six Bank Packages. The first two Bank Packages at the outset of the crisis involved guarantee programs that are the focus of this paper. The Bank Package I guarantee scheme (known in Denmark as the “General State Guarantee”) was introduced with the October 2008 passage of the Financial Stability Act, and the Bank Package II guarantee scheme (known in Denmark as the “Individual State Guarantee”) was based on a February 2009 amendment to the same Act. The main difference between the two guarantee schemes was their breadth. While the first was a blanket guarantee—covering essentially all Danish banks and all unsecured debt regardless of maturity, complexity, or any other terms or conditions of the instrument—the second required applications by individual credit institutions for specific debt issuances.

Bank Package I

The first Bank Package implemented in October 2008 consisted of two main components. First, it established an unlimited government guarantee for all claims of depositors and other unsecured creditors in Danish banks who were members of the Private Contingency Agency (a private consortium of Danish banks established in 2007), to the extent such claims were not otherwise covered by other programs such as the Danish Deposit Guarantee Scheme.^FNAct on Financial Stability specifies, “By simple creditors, this Act means depositors and creditors whose claims are not covered by sections 132 and 136 of the Financial Business Act. Creditors whose claims are based on covered bonds, cf. section 16 a of the Financial Business (SDO) Act, are not covered by the guarantee scheme in this Act.” Around the time of its implementation, this component of the package was often referred to as the “Guarantee Scheme” or the “General State Guarantee.” Its purpose was to “set up a safety net for two years” to “safeguard financial stability by contributing to the resumption of interbank lending” (State Aid NN51/2008). This blanket state-backed guarantee scheme expired in September 2010.

Secondly, the Bank Package I legislation also created a Winding-up Company, owned by the State, with a mandate to handle distressed firms and administer the guarantee scheme. If any scheme member banks failed, the Winding-up Company would ensure that “depositors and other unsecured creditors can be repaid pursuant to the guarantee in the context of an orderly winding up” (State Aid NN51/2008). In such a situation, the Winding-up Company would provide capital to a newly established company which would take over and wind up the failing bank. The Winding-up Company was originally designed with no set end date and still exists today. The Winding-up Company was initially named “Afviklingsselskabet til sikring af den finansielle Stabilitet.” Today it is named “Finansiel Stabilitet” and is also referred to as the Financial Stability Company.

The General State Guarantee operated on an all-in or all-out approach to the banks’ participation under the scheme rather than on applications for a state guarantee of individual issues of debt. The scheme’s underlying legislation, the Act of Financial Stability, was based on an October 5, 2008, agreement between the State and the Private Contingency Association (PCA) (a group simultaneously represented by the Danish Bankers Association) which stipulated that the PCA would be charged for the government guarantee through annual payments. The guarantee scheme covered only banks that requested by October 13, 2008, to become a member of the Danish PCA.^FNIn Danish the PCA is called the Det Private Beredskab (DPB) and is also sometimes translated as the Private Reserve Fund. Some translations of the Act on Financial Stability refer to the PCA more specifically as banks which contribute to the Private Emergency Banking, Savings and Shareholders' Compensation Fund.

The PCA’s extensive involvement in the design and funding of the General State Guarantee highlights Denmark’s collective, collaborative, industry-focused approach to addressing financial crises. The PCA was formed in 2007 by the banking industry. From 1994 until then, Denmark had operated a public deposit insurance scheme that was ultimately judged to be in violation of EU state aid rules in 2007 (Woll 2014). As a result, the Danish banking industry banded together and established the PCA as a private alternative for distressed banks. In 2008, the PCA was first tested when Roskilde Bank became distressed; the PCA took over joint ownership of Roskilde Bank with Danmarks Nationalbank (the central bank of Denmark). However, the failing bank’s major losses exhausted the PCA’s funds and thus underscored the need for an expanded government role in future winding-ups and financial sector interventions.

Through the PCA, the banking industry significantly contributed to the funding of the scheme, both by directly paying the government for the guarantee with DKK 15 billion and by contributing another DKK 10 billion to cover losses. The PCA also committed to contribute another DKK 10 billion to cover any further losses (although this second DKK 10 billion was never needed). The contribution of individual PCA-member banks was managed through the PCA. As a result of this funding structure, another way to conceptualize Bank Package I was as an industry-financed scheme where the State would only need to step in when losses exceed DKK 35 billion.

Bank Package II

In January 2009, the Danish government implemented Bank Package II via a legislative amendment to the Act on Financial Stability. Bank Package II had two parts: the Individual State Guarantee and a recapitalization scheme which gave banks access to capital through preferred shares acquired by the government for a total of potentially up to DKK 100 billion.

The Individual State Guarantee could cover newly issued debt with maturities of up to three years in order to “ensure the credit institutions have continued access to medium term liquidity and by that, avoi[d] the banks cutting off loans and credits” (State Aid N31a 2009). The government does not appear to have established minimum maturity requirements for eligible debt. At the time of implementation, this guarantee was known by some as the “Individual State Guarantee,” “Credit Scheme,” and/or the “Transition Scheme.” Under this program, all credit institutions which met minimum capital requirements, including commercial banks as well as mortgage credit institutions (which were not covered in the General State Guarantee), were able to apply for a state guarantee for individual issues of unsubordinated and unsecured debt and for issues of supplemental security for covered bonds or covered mortgage bonds. Any application for a state guarantee under this scheme had to be submitted no later than December 31, 2010.

Fees were calculated in line with the October 2008 recommendations of the Governing Council of the European Central Bank on government guarantees for bank debt and were based on the creditworthiness of the applying institution.

In order to achieve European Commission approval, the Danish government had to request an extension of the Individual State Guarantee every six months. The terms of the Individual Guarantee remained the same during the first two extensions. These included “remuneration, behavioural constraints, and reporting requirements” (State Aid N415 2009). Failure to comply with risk restrictions or other risky behavior could lead to exclusion from the schemes, after which it would not be possible for such banks or branches to re-enter. However, during the third extension, new “viability review requirements and an additional reporting obligation” were introduced and the guarantee fee increased in accordance with European Commission guidelines for extended guarantees (State Aid N257 2010). Specifically, the guarantee fee was increased to be higher than the original pricing formula recommended by the European Central Bank in October 2008 at least by 20 basis points for banks with a rating of A or A, 30 basis points for banks rated A-, and 40 basis points for banks rated below A- or banks without a rating (State Aid N257 2010).

While the total amount of guaranteed debt under the General Guarantee is not readily available, the amount was clearly substantial. Because coverage extended to all institutions that contributed to the PCA, effectively all of the Danish banking industry in terms of market share was covered (Woll 2014). Only 14 banks with inconsequential market share chose not to be covered (Gry Braad 2008).

The effectiveness of the guarantee schemes at avoiding bank failures in Denmark must be evaluated with the understanding that Denmark’s financial sector was dominated by small and medium-sized banks at the time of the Global Financial Crisis. For example, despite a total number of about 140 financial institutions operating in Denmark in 2008, only five had an operating capital of over DKK 50 billion and only an additional 12 had over DKK 10 billion in 2008 (Woll 2014). During Bank Package I in particular, the Winding-up Company known as Finansiel Stabilitet took over banking activities from eight failing banks. The amount of guaranteed debt that needed to be paid out and the overall cost of winding up distressed firms totaled around DKK 22.5 billion. However, despite the losses, by the end of the program, estimates indicated that Bank Package I generated an upside of DKK 2.5 billion for the Danish government. By the time Bank Package II initially expired in December of 2010, it had guaranteed debt issuances of about 50 institutions that totaled approximately DKK 194 billion.