not supportive of banking, and where savers were likely to see their savings go into the public coffers an early version of financial repression. – This is not an argument against reform of the financial system and the regulatory framework, but it is an argument in favour of taking a more holistic approach to the reforms. The models outlined above are models of individual institutions and the issue of their interaction has only been touched on briefly, cf the discussion on the formulation of LTV restrictions. On the one hand, limiting risks in one area may not limit overall risks, eg if risks are shifted to a part of the financial system that is more vulnerable. On the other hand, building institutions that are safer may require that risks are increased in other parts of the system. A more holistic approach should also take into consideration the fundamental changes that have happened in the financial industry over the last decades. For example, the mid to late 1970s, Denmark has seen not only exponential growth in banks' balance sheets relative to GDP, but also a very significant increase in the role of other financial intermediaries, such as life insurance and pension funds as well as investment associations (MFIs), cf Fig 11. Qualitatively similar developments can be seen in other EU countries, cf the ECB's Report on Financial Structures. Figure 11: Financial balance sheet developments relative to GDP in Denmark Source: Abildgren The increase in life insurance, pension fund and investment association savings constitutes an increase in savings that are less subject to run risk, if at all subject to such risk. This should some movement of long-term finance from banks to these other intermediaries. However, in this larger context, Solvency II may inhibit life insurers from taking on their natural role, given the large capital requirements imposed on credit risk in Solvency II. It is noteworthy that mortgage banks' balance sheets, which are dominated by mortgages on the asset side and covered bonds on the liability side, in most years far exceed the balance sheets of life insurers, pension funds and investment associations. Even today, the aforementioned institutions would have to spend an excessive amount of their resources were they to buy all
not supportive of banking, and where savers were likely to see their savings go into the public coffers – an early version of financial repression. This is not an argument against reform of the financial system and the regulatory framework, but it is an argument in favour of taking a more holistic approach to the reforms. The models outlined above are models of individual institutions and the issue of their interaction has only been touched on briefly, cf the discussion on the formulation of LTV restrictions. On the one hand, limiting risks in one area may not limit overall risks, eg if risks are shifted to a part of the financial system that is more vulnerable. On the other hand, building institutions that are safer may require that risks are increased in other parts of the system. A more holistic approach should also take into consideration the fundamental changes that have happened in the financial industry over the last decades. For example, the mid to late 1970s, Denmark has seen not only exponential growth in banks' balance sheets relative to GDP, but also a very significant increase in the role of other financial intermediaries, such as life insurance and pension funds as well as investment associations (MFIs), cf Fig 11. Qualitatively similar developments can be seen in other EU countries, cf the ECB's Report on Financial Structures. Figure 11: Financial balance sheet developments relative to GDP in Denmark Source: Abildgren The increase in life insurance, pension fund and investment association savings constitutes an increase in savings that are less subject to run risk, if at all subject to such risk. This should some movement of long-term finance from banks to these other intermediaries. However, in this larger context, Solvency II may inhibit life insurers from taking on their natural role, given the large capital requirements imposed on credit risk in Solvency II. It is noteworthy that mortgage banks' balance sheets, which are dominated by mortgages on the asset side and covered bonds on the liability side, in most years far exceed the balance sheets of life insurers, pension funds and investment associations. Even today, the aforementioned institutions would have to spend an excessive amount of their resources were they to buy all
nykredit_en.docx