Danish 'No' to the banking union could cost billions

It could be very expensive for Denmark to be left outside the Banking union

Summary The banking union can be viewed as an insurance scheme, and taking out insurance can result in costs in the form of insurance premiums. At the same time, the banking union is a special insurance scheme, with Denmark risking having to pay even more if we choose to operate outside the cooperation. The final bill will depend on the size of risk premium the financial markets believe Denmark should pay. However, there is significant risk that the bill will end up costing tens of billions of kroner.
In this memo, three different scenarios are examined: the Swedish, the critical and the British. Calculations based on the differences in interest rates show that the Swedish scenario could cost Denmark 1.4 million kroner a year, the critical 3.8 billion kroner per year and the British up to 11 billion kroner annually. If Denmark takes a wait-and-see approach to the banking union, we will stand outside of it for several (e.g. 5) years. This would bring the total amount of expenses up to between 7 and 55 billion kroner.
History shows that the financial crises are much worse than currency crises from a growth perspective. Financial crises are therefore more expensive, seen purely from a socio-economic perspective, than currency crises. The interest rate differentials indicate a currency risk, which pulls Think Tank EUROPA’s calculations in a conservative direction.
If Denmark stands outside the banking union, the Danish banks will need to give their capital buffers a boost. This in itself means increasing interest rates by introducing higher margins. This has been documented, for example, through thorough analyses conducted by the International Monetary Fund (IMF).

Main conclusion
  • It could cost Denmark tens of billions of DKK if it chooses to stand outside a European banking union and, as a result, the insurance scheme it covers.
  • If Denmark says “no”, the capital markets are very likely to demand a higher risk premium. This will be by no means free for Denmark if the government chooses a wait-and-see policy.
  • New calculations from Think Tank EUROPA show that these expenses could amount to somewhere between 1.4 and 11 billion kroner a year, depending on the financial markets’ assessment of the Danish risk.
  • Denmark could very well stand outside the banking union for at least five years. The worst-case scenario could see the cost soar towards 55 billion kroner.
  • The calculations are conservative, as they are based on the expenses incurred in having an independent currency. Meanwhile, experience shows that financial crises are more expensive than currency crises.
  • Capital requirements for the Danish banks will most likely increase if Denmark stands outside of the banking union. This means that banks will have to increase their margins, which corresponds to a higher interest rate. Each time the capital coverage ratio is increased by one percentage point, Danish interest rates will rise by 0.19 percentage points, analyses from the IMF show.
  • The Danish banks are most exposed to Sweden and the UK. However, these countries are exposed to the Eurozone, which means that Denmark is indirectly exposed to the Eurozone as well.

Tænketanken EUROPA indtager ikke holdninger som organisation. Denne tekst repræsenterer alene – som alle udgivelser fra Tænketanken EUROPA – forfatterens/forfatternes betragtninger.