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General and specific balance principle

Danish covered bond legislation came into force on 1 July 2007, and in many ways it changed the conditions for financing real property in Denmark.
 

The SDO legislation has changed the balance principle in the Danish mortgage banking system. It is now possible for issuers to choose between a general and a specific balance principle. Before the new legislation, there was only one balance principle.
 

The balance principle introduces absolute limits to the financial risk due to differences in terms between loans and bonds. The limits are based on the statutory capital adequacy rules.
 

The specific balance principle is virtually identical to the existing balance principle, whereas the general balance principle in some aspects represents a modernization of the specific balance principle. One of the changes consists of a wider scope for the liquidity risk, which is of importance to the financial stability.
 

Immediately after the SDO (covered bond) legislation had been passed, the mortgage banks were required to make a decision about their choice of balance principle. Two mortgage banks chose the general principle and four the specific balance principle. However, that is not the most interesting thing – the most interesting thing is the fact that in practice the mortgage banks have – with no exception – chosen to continue with the match funding between mortgage credit lending and bond issuance.
 

The differences between the two balance principles are as follows:
 

Types of risk Specific balance principle General balance principle

Interest rate risk

Stress test on level and structure
+
Loss limit of 1 per cent of capital base
+
Risks in different currencies cannot be set off

Stress test on level and structure

 

Loss limit for mortgage banks dependent of stress test:
1 per cent/ 5 per cent of capital adequacy requirement +
2 per cent/10 per cent of the additional excess cover

 

Loss limit for commercial banks depent of stress test:
10 percent/100 percent of excess cover
Currency risk Exchange rate indicator 2 (few currencies)
+
Loss limit of 0.1 per cent of capital base

Simple stress test

 

Loss limit for mortgage banks:
10 pct. of capital adequacy requirement +
10 per cent of the additional excess cover
for EUR and 1 per cent of capital adequacy requirement + 1 per cent of additional excess cover
 of other currencies

 

Loss limit for commercial banks
10 percent of excess cover
Option risk  Maximum term of 4 year
+
Structural limits on call options and index-linking

 Stress test on volatility

 

Loss limit for mortgage banks:
0,5 per cent of capital adequacy requirement +
1 per cent of the additional excess cover
No maturity or structural limits

 

Loss limit for commercial banks
5 percent of excess cover
No maturity or structural limits
Liquidity risk  Limitations on temporarily liquidity deficits
25 per cent (years 1-3)
50 per cent (years 4-10)
100 per cent (from year 11)		 Limitations on interest payments:
Interest (in) > Interest (out) (over a current period of 12 months)
+
Present value
PV (in) > PV (out) (always)  
Repayment of loans by bonds other than the underlying bonds  Max. 15 pct.
Both own issued bonds and bonds from other credit institutions
+
Approximately same cash flow		 Max. 15% from other credit institutions
- Own issued bonds unlimited
 

 

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