Denmark: Financial System Stability Assessment with reports on - IMF

16C. Mortgage Credit Banks22. Danish mortgage financing system is profitable, transparent, and effective indelivering low cost mortgage financing to borrowers. Specific legislation, allowsspecialized mortgage credit institutions to issue mortgage bonds on behalf of the borrowers.The framework is supported by an effective system of land registration as well as clearlydefined procedures for foreclosures. With total assets close to 135 percent of GDP, mortgagecredit institutions are slightly smaller than the commercial banks and their reportedsoundness indicators are good (Table 3). Mortgage bonds as well as the mortgage creditinstitutions are highly rated by international rating agencies, and mortgage bonds areaccepted by the Nationalbank as collateral.23. The mortgage credit system faces significant challenges. In recent years mortgagefinancing has undergone several changes and new products have emerged, including variableinterest rates, deferred amortization, and capped adjustable rate loans. Variable rate mortgageloans now account for about half of all such loans. New types of loans necessitate new typesof bonds to observe the balance principle. The wider range of mortgage products couldnegatively impact the overall pricing and liquidity of the mortgage market if it results in aless homogeneous mortgage market <strong>with</strong> a series of smaller and less liquid bonds. This couldaffect the appetite of investors—mostly institutional investors—for Danish mortgage bonds. 1024. The impending EU regulation on covered bonds is likely to pose a transitionalchallenge for the Danish mortgage system. As covered bonds, the loan to value onmortgage bonds will need to be observed continuously instead of only at the origination ofthe loan. Besides mortgage credit institutions, banks would be allowed to issue such coveredbonds. This would allow more funding flexibility, but would tend to limit the direct access tothe capital market provided to the borrower under the current system. In principle,competition should ensure efficient pricing of covered bonds. However, the two largest banksand regional banks as a group would be in a more advantageous position to issue coveredbonds because of their branch networks and greater proximity to customers. With a broaderrange of available collateral and possibilities to provide additional capital, banks would be ina better position to adapt to loan to value fluctuations compared to mortgage financeinstitutions. Realization of the potential long run benefits of covered bonds would place aheavy premium on effective disclosure and transparency and a level playing field amongmarket participants.10 See “Trends in Mortgage-Credit Financing: the Market and its Players,” by Lars Jul Hansen, in MonetaryReview, 1 st Quarter, 2006, Danmarks Nationalbank, Copenhagen.