Frequently asked questions

• Changed market conditions:
  The financial industry has become highly globalised.
  
• Improved techniques for risk management:
  Many banks have adopted highly advanced risk management techniques which make it evident that the static and broad-brush approach in Basel I is insufficient. It does not capture and mirror the true risk picture of banks.
  
• Regulatory dialectic:
  With the introduction of CRD, the regulators have taken an important step in bridging the gap between the internal models of the financial industry and the regulators' models and requirements for regulatory capital. The use of internal models will be incorporated in order to ensure more agile and responsive regulation and capital adequacy. Standard models provided by a supervisory authority are often "post-event models" and are usually under construction for several years.

What are the main differences between Basel I and Basel II?
Basel II builds on Basel I and there are a few similarities between the two frameworks: The definition of capital and the minimum capital requirement (8%). It is the Basel Committee's intention generally to maintain the level of capital in the banking system.

However, there are also important differences between the two frameworks. The differences are described on an overall level in the figure below:



Basel II introduces the use of internal models for estimating risks. It also introduces a more risksensitive standardised framework, operational risk and increased coverage of asset securitisation.

Pillar II (Supervisory review) and Pillar III (Market discipline) are also new features.

When will CRD be implemented?
The implementation of the CRD is a gradual process.

Will there be any restrictions on capital releases when moving into the world of CRD?
Yes, there will be some restrictions on capital releases.

The regulators have ensured a gradual capital release by introducing capital floors for those banks choosing advanced methods for credit risk estimation. The capital floors, which depend on the method chosen, are presented in the table below.

The capital floors are based on a bank's capital requirement under Basel I. A bank choosing the IRB Foundation approach can therefore release 5% of its capital requirement under Basel I in 2007, a further 5% in 2008 and a further 10% in 2009. The full benefits from the CRD therefore cannot be enjoyed until in 2010.

Will banks be allowed to account for diversification between risk types?
The risk-weighted assets for credit risk, market risk and operational risk should be aggregated in the total risk-weighted items measure. In Denmark it is yet uncertain whether banks will be allowed to account for correlation between the various risk types when aggregating the three numbers. The UK FSA recommends not adjusting for the correlation between the various risk types.

Will Danske Bank get a capital relief when moving into the world of CRD?
In the course of 2006, Danske Bank established internal processes for assessment of future capital requirements, the Internal Capital Adequacy Assessment Process (ICAAP), as dictated by the CRD.
In December 2006, the Board of Directors approved the Group’s first ICAAP report.

Until now, Danske Bank's work on the internal ratings-based method was based on five-to-seven-year time horizons to determine long-term averages for estimating the risk parameters included in the calculation of the Pillar I requirements, whereas the risk of rarer cyclical situations was covered by using relevant stress scenarios under Pillar II.

Applying the IRB approach to the Danske Bank Group’s financial results for 2007 would reduce risk-weighted assets (Pillar I and Pillar II) by 23% on full implementation in 2010.

The capital target of the Group will be based on the minimum capital requirement under Pillar I and further capital requirements under Pillar II, including stress tests and rating ambitions. The Annual Report for 2007 further explains the effect of the new requirements on the Group’s capital management and financial targets.

The Group conducts a number of stress tests during ICAAP to ensure that its capital will also be adequate under unfavourable economic conditions. During the tests, the Group’s risk portfolio is exposed to more severe stress conditions than the conditions experienced during the economic downturn at the beginning of the 1990s. The increase in the capital needed resulting from these stress tests is part of the Pillar II capital requirement.

The risk-weighted assets in Pillar I (according to the CRD) are calculated using internal risk parameters, which are assessed conservatively considering the currently favourable economic climate.

Danske Bank’s capital policy, which aims to ensure that the Group’s capital supports business growth and helps to maintain the Group’s ratings, stipulates that the Group should maintain an excess cover relative to the statutory requirement. This policy will not be changed, and Danske Bank will maintain an excess cover in the future.

Are there any structural factors working to Danske Bank's advantage in the world of CRD?
There are a number of factors that may be beneficial for Danske Bank under the new capital adequacy rules:

• A large mortgage portfolio, with very low expected losses over a business cycle (2 bp)
  
• A good diversification of credit risk between countries, customer segments and industries
  
• A high and stable internal capital generation
  
• Sound risk, capital and performance management
  
  

The Group’s credit risk has been reduced in recent years as a result of a relative increase in mortgage loans and similar loans which carry a low risk. During the same period, the Group has increased its exposure to selected global financial institutions with high credit ratings. Furthermore, the Group enters into an increasing number of collateral management and netting agreements.

On the acquisition of Sampo Bank, the Bank lowered its core (tier 1) capital target from 6.5-6.0 to 6.0-5.5. The change was driven by the expected effects of CRD implementation.
Read more about the Sampo deal.

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Pillar I
What risk types does the CRD cover?
The Pillar I of CRD covers credit risk, market risk and operational risk.

What is credit risk?
Credit risk is the risk of loss because counterparties fail to meet all or part of their obligations. This risk type is normally the largest risk exposure for retail banks. Credit risk includes country risk and settlement risk.

• Country risk is the risk of losses arising from the economic or political circumstances in a country. Country risk also encompasses the risk of nationalisation, expropriation and debt restructuring.
  
• Settlement risk is the risk arising from the settlement of payments for securities, derivatives and other trades when a bank remits payments before it can ascertain that the offsetting payments have been transferred to one of the bank's accounts.

What models for credit risk measurement are allowed under the CRD?
The CRD allows three methods for credit risk measurement:

• Standardised approach
  
• Internal Rating Based (IRB) Foundation Approach
  
• Internal Rating Based (IRB) Advanced Approach

Read more about the different models.

What are the main differences between the IRB Foundation Approach and the IRB Advanced Approach?
There are two versions of the IRB Approach, the Foundation and the Advanced Approach. The main difference is that the latter permits the use of more internal inputs.

• Interest rate risk is the risk of losses because of changes in interest rates.
  
• Currency risk is the risk of losses on the Group's positions in foreign currency because of changes in exchange rates.
  
• Equity market risk is the risk of losses because of changes in equity prices.

What models for market risk measurement are allowed under the CRD?
CRD includes two methods to measure market risk:

• Standardised Approach
  
• Internal Models Approach

Read more about the different models.

What is operational risk?
Operational risk, or event risk, is the risk of losses because of deficient or erroneous internal procedures, human or system errors, or external events. This risk type is not included in the current capital adequacy rules (Basel I).

What models for operational risk measurement are allowed under the CRD?
There are three methods for measuring operational risk:

• Basic Indicator Approach
  
• Standard Approach
  
• Advanced Measurement Approach

Read more about the different models.

What models will Danske Bank use?
Danske Bank has chosen the following methods:

What are the objectives behind Pillar II?
Pillar II specifies the framework for the supervisory review process and sets a framework for further capital requirements based on the situation and characteristics of the individual institution. Pillar II also encompasses risk not defined under Pillar I (i.e. concentration and residual risk) as well as stress testing.

One of the most important objectives of Pillar II is to encourage banks to set internal capital targets which are in line with the individual bank's operations and risk exposure.

Read more about Pillar II.

What is ICAAP?
The Internal Capital Adequacy Assessment Process (ICAAP) ensures that management

• adequately identifies and measures the bank's risks
  
• maintains adequate internal capital in relation to the bank's risk profile
  
• uses sound risk management systems and develops them further

The CRD states that banks should "own", develop and manage their ICAAP. The regulators should not dictate the use of the process. Instead they should review and evaluate both the ICAAP and the soundness of the internal governance processes in which the ICAAP is embedded.

What is stress testing?
Stress tests are important tools for analysing a bank's risk profile. Stress tests identify the central risk drivers and analyse the effect of significant negative shocks to these risk drivers. The effects can be measured in both profit and loss and balance sheet terms.

Danske Bank has conducted a number of Groupwide stress tests since 2005 at regular intervals. The stress tests show how the Group will fare if it suffers various economic shocks over a period of three to five years.

Read more about Danske Bank's stress tests.

What scenarios does Danske Bank use in its stress tests?

Scenario	Brief description
Recession (1 in 25) Period covered: 3 years Macro, worst year: GDP -2.1% Unemployment 9.9% Property prices -14.2%	Sharp fall in exports and rising taxes lead to decline in demand
Deflation Period covered: 5 years Macro, worst year: GDP -1.0% Unemployment 15.2% Property prices -8.0%	Structural problems in Europe lead to recession and deflation
Falling property prices Period covered: 5 years Macro, worst year: GDP 0.4% Unemployment 9.4% Property prices -12.2%	Rising interest rates lead to a fall in housing prices
Mild recession Period covered: 3 years Macro, worst year: GDP 1.4% Unemployment 6.4% Property prices 0.7%	Zero growth two quarters in a row
Oil price hike Period covered: 3 years Macro, worst year: GDP 2.1% Unemployment 5.6% Property prices -1.1%	Sharp increase in oil and commodity prices leads to lower purchasing power (consumers and companies)
Fall in US dollar Period covered: 3 years Macro, worst year: GDP 2.0% Unemployment 5.9% Property prices 0.9%	Deficit in the US trade balance leads to a global recession
Liquidity crisis, sector	Liquidity crisis which leads to credit losses and a negative effect on funding
Liquidity crisis, Danske Bank	Default by one of Danske Bank's largest customers and a downgrade on Danske Bank's rating
Epidemic	14,000 die, including 4,000 employed

How many years are included in Danske Bank's stress tests?
The stress tests show how the Group will fare if it suffers various economic shocks over a period of three to five years.

How well does Danske Bank's stress testing methodology compare with the Bank of England's?
Danske Bank has compared its stress testing methodology with Bank of England's. The main conclusion is that the methodologies are very similar.

Step	Bank of England	Danske Bank
Start	Identifying systemic vulnerabilties	Identification of key risk drivers
I	Construction of stress scenarios	Choice of scenario
II	Mapping transmission channels to banks	Translation of scenario
III	Measuring risk transmission channels	Stress test calculation
IV		Assessment of results and approaches

Read more about the comparison.

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Pillar III

What does Pillar III cover?
Pillar III includes a number of recommendations and requirements to increase and improve disclosure.

Read more about Pillar III.

How will Danske Bank handle the increased disclosure?
Danske Bank's interactive report on risk and capital management fulfils many of the requirements mentioned above and the other requirements stated in the directive.

The interactive report will be further developed, and Danske Bank's aim is that it will be the medium used for complying with the requirements in Pillar III.

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Last updated/revised on January 31, 2008