Danske Bank Crisis Has a Warning for All Banks

(Bloomberg) -- Danske Bank A/S has been dealing with negative interest rates longer than any other major lender. That’s why its latest crisis, which cost a top executive his job, carries an important warning for peers in Europe.

The biggest bank in Denmark, where benchmark rates have been negative since July 2012, is best known for its role at the center of a vast money-laundering scandal. Last month, it was hit by another embarrassment after overcharging retail clients for investment products. Danske should have followed rules that require investors to be offered the best deal, even if that hurts the bank -- in this case, regular deposits, where returns are around zero.

The problem for Danske and others coping with negative rates is that the more money they hold in deposits, the greater the cost. Banks have balked at passing on the burden of negative rates to retail savers for fear of losing business. Instead, they’ve looked for ways to mitigate the pain, such as focusing on services that carry fees.

Jesper Berg, the director general of the Financial Supervisory Authority in Copenhagen, says that the Danske case now “shows that the fee channel is also threatened” for banks dealing with negative rates.

The Last Bright Spot

Fee income was one of the last bright spots for an industry in which key business areas have been hampered by negative rates.

In the past, banks would “make money from getting cheaper [deposit] funding than market funding," Berg said. "That channel throughout Europe is dead.” They would also profit from taking short-term duration risks, “but the yield curve is flat right now, or in that neighborhood, so they don’t get that 1% or 2% which they historically got on doing that sort of business.” And now, negative rates are eating into fee income, he said.

Go back a few years, and the narrative was that Danske had successfully adapted its business model to cope with negative rates. It delivered record profits in 2017, after half a decade of Danish benchmark rates below zero. That was also the year that Danske raised fees for customers who put money into an investment platform called Flexinvest Fri.

But the returns on some of those products were low. By the time the higher fees were included, clients were losing money. The bank nevertheless recommended the product and collected the fees.

The kind of fees Danske was charging constitute “a significant part of fee income in many banks across Europe,” Berg said. “If that is threatened, there is a more generic issue across Europe.”

As the prospect of returning to positive interest rates in Europe seems more remote, the impact of the policy on the region’s banks warrants attention. In Denmark, finance industry profits were down 25% in 2018, according to FSA data. Berg says his agency is now starting to worry about profitability among banks.

“Typically the issue has been, we lean against the wind because of bubbles,” he said. “But now it is an issue of the earnings power of banks.”

In Denmark, part of the effect is mitigated by the funding model behind the country’s huge mortgage industry, which relies on the world’s biggest covered-bond market.

“We are in a fortunate position in this country where banks make a decent amount of money. They’re very capitalized. They can rely to a large extent on covered bonds for funding,” Berg said.

Meanwhile, Danske continues to face fines potentially in billions of dollars over the Estonian money-laundering scandal. On Thursday, the Berlingske newspaper reported that an existing investigation into the bank has been expanded to include its decision in 2014 to fire a company it had hired to examine warnings by a whistle-blower.

Since the beginning of last year, Danske Bank shares have plunged by about 57% as shareholders fled the scandals.

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editors responsible for this story: Tasneem Hanfi Brögger at tbrogger@bloomberg.net, Paul Sillitoe

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