## 1. Robust Danish and Swedish Bank Performance

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### I. Introduction and context
- Negative policy interest rates were introduced in Denmark and Sweden and raised concerns about impacts on bank profitability via pressure on net interest margins.
- Negative interest rates aim to support macroeconomic objectives but can compress banks’ net interest margins, especially where banks cannot generate greater revenues (for example, by charging fees to depositors).
- Literature highlights:
  - Long-run positive relationship between the level of interest rates and bank profitability; short-run higher rates can be negative due to repricing frictions (Alessandri and Nelson (2015); Busch and Memmel (2015)).
  - Low interest rates and a flat term structure can significantly erode bank profitability; non-linearities possible when starting from already low levels (Borio, Gambacorta, and Hofmann (2015)).
  - Positive impacts from boosting economic activity (including on lending volumes and performance of existing loans) may outweigh adverse effects of low or negative rates on bank profitability (Genay and Podjasek (2014)).
- Empirical observation: Banks have generally avoided applying negative interest rates to retail deposits, contributing to downward stickiness in funding costs. Footnote: "There is no evidence of cash hoarding by customers in Denmark and Sweden (BIS, 2016)."

### II. Key factors shaping the impact of negative rates on bank profitability
- Deposit-rate stickiness at low policy rates is a central factor.
- Funding composition:
  - Wholesale funding costs tend to fall as negative policy rates affect money markets and the yield curve.
  - A larger share of wholesale funding reduces the impact of negative policy rates on overall net interest margin.
  - Funding cost savings accrue more quickly if wholesale funding is closely linked to current market rates (short maturities, floating rate liabilities, or interest swaps on fixed rate bonds).
- Asset repricing:
  - Income from loan portfolios declines faster if the share of variable-rate loans is high.
  - Option to refinance loans at new lower interest rates can produce similar effects even where outstanding loans are not variable.
  - Current shares: "50 percent of bank loans in Denmark and more than 90 percent of bank loans in Sweden carry a variable rate with short-term fixation period less than one year."
- Other income sources affecting overall profitability: income from security holdings, asset management, fees and commissions, operating costs, and loan loss provisions.

### III. Scope and analytical approach
- The paper assesses:
  - Pass-through of low and negative interest rates into bank interest rates and wholesale funding costs in Denmark and Sweden.
  - Developments in retail interest rates, with information on stickiness and repricing.
  - Estimates of wholesale funding costs at Swedish banks, where non-deposit funding supports about half of loans.
- The study examines earnings of main subsidiaries of large banks in Denmark and Sweden during the period of negative interest rates.
- At the group level, large banking conglomerates appear to be "weathering well the challenges of operating in a negative interest rate environment" (Danmarks Nationalbank, 2015a; Sveriges Riksbank, 2016a).

### IV. Pass-through of negative policy rates to bank rates and wholesale funding costs
- Timeline and context:
  - Danmarks Nationalbank (DN) introduced negative policy rates on its deposit facility in July 2012; initial CD rate -0.2 percent, raised to -0.1 percent in January 2013; returned to negative CD rate in September 2014; announced -0.5 percent CD rate in January 2015 that was soon cut to -0.75 percent.
  - ECB deposit rate turned negative from June 2014.
  - SNB 3-month Libor target rate went negative in December 2014.
  - Sveriges Riksbank policy rates became negative in early 2015.
  - DN purchased foreign exchange amounting to 13 percent of GDP to preserve the peg during large capital inflows in early 2015.
- Deposit-rate stickiness:
  - Interest rates on new deposit agreements declined but remained at or above zero even when the policy rate became significantly negative; banks in Sweden refer to a “zero floor.”
  - Sensitivity of retail deposit rates in Sweden to the repo rate appears to have declined after the repo rate dropped below 0.5 percent in July 2014.
- Lending rates and margins:
  - Lending rates declined in both Denmark and Sweden, with a larger fall in Sweden; Swedish new-loan interest rates declined broadly in parallel with the policy rate after February 2015.
  - Denmark: lending-deposit margins averaged 1.5 percent between July 2012 and March 2016, in line with the mean in the three years before negative rates.
  - Sweden: margins averaged 2.6 percent in 2011–14, but fell to just below 2 percent since February 2015 as deposit rate declines slowed relative to lending rate decreases.
- Wholesale funding and covered bonds:
  - Danish mortgage banks (MB) finance housing loans solely by issuing covered bonds under the “balance principle” and realize administrative fees from mortgage origination and servicing; increase in fees since negative rates contributed to solid MB margins.
  - Swedish banks rely heavily on non-deposit funding, including foreign currency funding swapped into SEK; funding structure noted as deposits and non-deposit funding sources at 48 and 52 percent, respectively.
  - Banks issue covered bonds in domestic and foreign currency and use interest rate swaps to hedge interest rate risk between covered bonds and mortgages.
- Wholesale funding cost pass-through:
  - Estimates of overall funding costs from covered bonds have continued to fall in line with the repo rate since negative rates were introduced.
  - Pass-through from negative interest rates to money market rates and funding-cost estimates on covered bonds in SEK and Euro has been sizable since negative rates were introduced.
  - Taking account of shares of new covered bond issuance in domestic and foreign currency, decline in total funding cost on covered bonds closely matched the reduction in the repo rate since February 2015.
  - Reductions in wholesale funding costs since February 2015 have safeguarded bank margins despite deposit-rate stickiness.
  - Caveat: “the use of non-core liabilities could raise financial stability concerns, since this type of funding is more unstable and prone to sharp reversals in time of crisis.”

### V. Banking in a negative interest rate environment — empirical observations and business models
- Data and sample:
  - Uses unconsolidated financial statements for commercial banks (CB) and mortgage banks (MB) from Bankscope over 2005–15.
  - Sample includes 4 large CB from Denmark and Sweden, and 4 and 3 MB from Denmark and Sweden, respectively.
- Business model differences:
  - CB offer broader products (unsecured and secured loans, overdrafts, investment products, checking accounts, term deposits); MB do not accept deposits and specialize in originating/servicing mortgage loans, earning spreads as loan servicing and origination fees.
  - Danish CB hold a notably larger portion of assets in securities (rather than loans) than Swedish CB.
  - In both countries, customer deposits account for less than half of funding, implying substantial use of wholesale funding.
  - MB assets almost entirely mortgage loans with primarily long-term funding.
- Credit trends and profits:
  - Denmark: CB lending has declined since 2008; MB lending slowed since 2012 due to subdued demand.
  - Sweden: lending expanded during 2015, supporting bank profits in Krona terms.
  - Profits:
    - Swedish MB profits continued upward trend in 2015.
    - Danish MB profits stable in 2012–14 then increased in 2015 when rates were most negative.
    - Danish CB registered strong results in 2015 after gradual decline in 2012–14.
    - Swedish CB profits slightly declined in 2015 but remained close to historic highs.

### VI. Income structure and net interest margins
- Net interest margins (NIM) and income composition:
  - For banks in Denmark and CB in Sweden, NIM and net other income remained near their averages prior to the period of negative interest rates.
  - MB profitability in Sweden rose since negative interest rates were introduced early 2015, maintaining an upward trend.
- Drivers of stable NIM:
  - Interest income relative to assets declined for all banks, reflecting strong pass-through from negative policy rates to lower lending rates.
  - Interest expenses fell significantly to historic lows in relation to earning assets, cushioning NIM despite lower interest income.
  - Deposit-rate declines were limited; interest expense reductions largely attributable to reduced costs from non-deposit funding.
  - Reduction especially pronounced at MB in Sweden in 2015, owing to cheaper short-term funding and use of interest swaps on long-term funding; reduction more gradual in Denmark.
- Net other income and fees:
  - Net other income improved only slightly for CB and was little changed for MB.
  - Danish CB raised substantially more income from fees and commissions during the negative-rate period, partly offset by higher non-interest expenses.
  - Swedish CB non-interest sources (fund management, advisory) remained steady in 2015 with small improvement in net other income due to reduced non-interest expenses.
  - MB activities limited to mortgage lending; non-interest income and expense relatively small.

### VII. Profitability metrics, market reactions, and credit risk pricing
- Pre-provision returns and equity markets:
  - No noticeable deterioration in banks’ bottom lines following introduction of negative rates.
  - Pre-provision ROE slightly declined for CBs in Denmark; remained flat for CB in Sweden after negative rates, albeit at a high level.
  - MB pre-provision ROE rose to its 2005 high in Denmark; continued strong upward trend in Sweden.
- Equity price changes since January 2012:
  - Denmark: 125 percent
  - Sweden: 76 percent
  - Euro area: 15 percent
  - UK: -8 percent
  - Germany: -28 percent
- Repo rate levels noted:
  - Sweden 2016: -0.5 percent
  - Sweden 2015: close to -0.25 percent
- Bank credit risk pricing:
  - Change in counterparty credit risk as reflected in CDS spreads has been lowest in Denmark since first introduction of negative rates.
  - In Sweden, negative rate cuts do not seem to have had any impact on bank CDS spreads while spreads for banks from Germany, the U.K., and the broader EA spiked.
  - Recent rises in CDS spreads in Denmark and Sweden are driven by a broader repricing of bank credit risk.

### VIII. Key quantitative facts and structural metrics (EBA-based / reported figures)
- EBA-based metrics (June 2015 / 2015H1):
  - Net fees and commission account for 22 percent of Danish banks’ earnings structure; Netherlands 15 percent; Sweden 29 percent.
  - Ratio of non-interest expense to operating income:
    - Sweden: 47 percent
    - Denmark: 50 percent
    - Germany: 74 percent
    - Netherlands: 53 percent
    - U.K.: 58 percent
  - Total capital ratios:
    - Danish banks: 20 percent
    - Swedish banks: 25 percent

### IX. Analysis, risks, and potential future developments
- Factors limiting adverse profitability effects to date:
  - High reliance on non-deposit funding in Denmark and Sweden.
  - Sizable pass-through from negative policy interest rates to the cost of wholesale financing, cutting overall interest expenses to historically low levels.
  - Commercial bank profitability in Denmark cushioned by rising non-interest revenues from fee income (mortgage refinancing, corporate advisory), partially offset by higher non-interest expenses.
- Risks that could materialize:
  - Full adverse impact on CB profits may remain to be observed because:
    - Policy rates only became significantly negative in 2015; loans with longer rate-fixing periods may be repriced or roll over at lower prevailing rates in coming years.
    - Limits to banks’ ability to further increase non-interest revenues via fees.
    - Room for further cost reduction from interest expense compression could be restricted with deposit rates floored.
    - Evidence of less than complete pass-through of negative rates into wholesale funding costs.
  - Sweden-specific risks:
    - High share of variable-rate loans implies limited additional impact from further repricing, but greater impact possible in 2016 with repo rates averaging -0.5 percent.
    - If foreign bond yields were to rise, a rise in Swedish yields, including for covered bonds, may reduce the low-cost wholesale funding cushion.
  - Non-interest income gains may be temporary once loan refinancing completes or under competitive pressure.
  - Extended profitability compression could pose risks to the quantity and quality of lending and therefore requires careful oversight.

### X. Policy implications and monitoring priorities
- Continue close monitoring of bank profitability indicators:
  - Net interest income and composition (interest income vs. interest expense).
  - Net other income components (fees & commissions, other non-interest income, non-interest expense).
  - Pre-provision return on equity and provisions trends to detect deferred loss recognition.
- Monitor funding cost dynamics and pass-through:
  - Wholesale funding costs and availability, including covered bond yields.
  - Deposit-rate behavior and the extent of deposit-rate stickiness.
- Watch durability of non-interest revenue gains:
  - Fee income sources such as mortgage refinancing and advisory services may be temporary or subject to competitive pressures.
- Assess loan repricing timelines and exposure:
  - Share and maturity structure of loans with longer rate-fixing periods.
  - Potential future repricing impacts on interest income as longer-term loans roll over.

### XI. Appendices and supplementary materials (summary)
- Appendix I (Cost of Funding from Covered Bonds in Sweden):
  - SEK covered bond proxy cost = 3-month Stibor + cost of interest hedging (difference between SEK covered bond yield and SEK interest rate swap yield of same maturity); 3-year moving average window for hedging costs.
  - EUR covered bond proxy cost = 3-month Euribor + interest hedging costs (EUR covered bond yield—EUR interest swap yield) + cost of a cross-currency basis swap SEK/EUR; 2-year moving average window for hedging costs.
  - Overall covered bond funding cost = weighted average of SEK and EUR funding using shares of new covered bond issuance as weights.
  - Footnote: 70 percent of housing loans have an original fixation period of less than 3 months in Sweden.
- Appendix II lists commercial and mortgage banks considered at the unconsolidated level (selected entries include Danske Bank A/S; Nordea Bank AB (publ); Jyske Bank A/S; Skandinaviska Enskilda Banken AB; Svenska Handelsbanken; Swedbank AB; and corresponding mortgage banks such as Nordea Kredit Realkreditaktieselskab; Nykredit Realkredit A/S; Realkredit Danmark A/S; Swedbank Hypotek AB; Swedbank Mortgage AB; Totalkredit A/S).
- Appendix III shows selected entries of banks included in the EBA dataset at the highest consolidated level (selected entries for Germany, Denmark, Finland, Netherlands, Norway, Sweden, United Kingdom).

*Source: _wp16198 — Chapter 1, "Robust Danish and Swedish Bank Performance."*

### 1. Robust Danish and Swedish Bank Performance ..................................................................20

### 1. Robust Danish and Swedish Bank Performance ..................................................................20

### I. Introduction and context
- With the introduction of negative policy interest rates in Denmark and Sweden, concerns arose about impacts on bank profitability through pressure on net interest margins.
- Negative interest rates are intended to support macroeconomic objectives but can compress banks’ net interest margins, especially for banks unable to generate greater revenues (for example, by charging fees to depositors).
- Literature summarized:
  - Alessandri and Nelson (2015) and Busch and Memmel (2015): long-run positive relationship between the level of interest rates and bank profitability; short-run higher rates can be negative due to repricing frictions.
  - Borio, Gambacorta, and Hofmann (2015): low interest rates and a flat term structure can significantly erode bank profitability; potential non-linearities with larger effects when starting from already low levels.
  - Genay and Podjasek (2014): positive impacts from boosting economic activity (including on lending volumes and performance of existing loans) may outweigh adverse effects of low or negative rates on bank profitability.
- Empirical observation: Banks have generally avoided applying negative interest rates to retail deposits, contributing to downward stickiness in funding costs. Footnote: "There is no evidence of cash hoarding by customers in Denmark and Sweden (BIS, 2016)."

### II. Key factors shaping the impact of negative rates on bank profitability
- Downward stickiness in deposit rates at low policy rates is a key factor; other important factors include:
  - Funding composition:
    - Costs of wholesale funding for banks tend to fall as negative policy rates impact money markets and the yield curve.
    - A larger share of wholesale funding reduces the impact of negative rates on overall net interest margin.
    - Funding cost savings accrue more quickly if wholesale funding is more closely linked to current market rates (short maturities, floating rate liabilities, or interest swaps on fixed rate bonds).
  - Asset repricing:
    - Income from loan portfolios declines faster if the share of variable rate loans is high—lending rates on existing loans decline as well as on new loans.
    - Option to refinance loans at new lower interest rates can produce similar effects even where rates on outstanding loans are not variable.
    - Currently, "50 percent of bank loans in Denmark and more than 90 percent of bank loans in Sweden carry a variable rate with short-term fixation period less than one year."
  - Other income sources:
    - Overall bank profitability also depends on income from security holdings, asset management, fees and commissions, and non-interest expenses (operating costs and loan loss provisions).

### III. Scope and analytical approach of the paper
- The paper assesses:
  - Pass-through of low and negative interest rates into bank interest rates and wholesale funding costs in Denmark and Sweden.
  - Developments in retail interest rates in Denmark and Sweden, with information on stickiness and repricing.
  - Estimates of wholesale funding costs at Swedish banks, where non-deposit funding supports about half of loans.
- The study examines earnings of the main subsidiaries of large banks in Denmark and Sweden during the period of negative interest rates.
- At the group level, large banking conglomerates appear to be "weathering well the challenges of operating in a negative interest rate environment" (Danmarks Nationalbank, 2015a; Sveriges Riksbank, 2016a).

### IV. Main findings and observations (as presented)
- Large Danish and Swedish banking groups:
  - Are profitable and well capitalized (Box 1 referenced).
  - Activities spread across different markets and business segments (commercial banking, mortgage financing) can mitigate effects from domestic interest rate compression.
- Funding and repricing implications:
  - Wholesale funding cost declines can offset some margin compression where wholesale funding is substantial and sensitive to current market rates.
  - High prevalence of variable-rate loans, especially in Sweden (more than 90 percent), implies faster transmission of lower policy rates into loan income.
- Overall concern:
  - A reduction in bank profitability could be problematic if it impeded lending and growth, but the paper notes offsetting forces (e.g., higher lending volumes, improved loan performance) that may mitigate adverse effects.

### V. Structure of remainder of paper (as signposted)
- Section II: brief overview of negative interest rates in Europe and motivations behind their introduction.
- Subsequent sections (described in the front matter and figures/tables list) analyze:
  - Pass-through to retail rates, impact on lending-deposit margins, wholesale funding costs (covered bonds and spreads), asset composition, funding structure, bank rates, developments in bank lending and profits, earnings structure, net interest income components, net other income components, returns on equity and equity prices, and bank credit risk around negative rate announcements.
- Appendices indicated include:
  - Cost of Funding from Covered Bonds in Sweden; lists of commercial and mortgage banks at unconsolidated level; banks included in the EBA dataset at the highest consolidated level.

*Source: IMF staff summary of Chapter 1, "Robust Danish and Swedish Bank Performance."*

### Section III discusses the pass-through of negative interest rates to bank rates and wholesale

### Section III discusses the pass-through of negative interest rates to bank rates and wholesale funding costs

### Brief overview of negative interest rates in Europe
- Four central banks in Europe have steered nominal rates into negative territory since 2012.
- Danmarks Nationalbank (DN) introduced negative policy rates on its deposit facility in July 2012; initial CD rate -0.2 percent, raised to -0.1 percent in January 2013; returned to negative CD rate in September 2014; announced -0.5 percent CD rate in January 2015 that was soon cut to -0.75 percent.
- European Central Bank (ECB) deposit rate turned negative from June 2014.
- Swiss National Bank (SNB) 3-month Libor target rate went negative in December 2014.
- Sveriges Riksbank (RB) policy rates became negative in early 2015.
- DN purchased foreign exchange amounting to 13 percent of GDP to preserve the peg during large capital inflows in early 2015.
- In Sweden, negative policy rates were implemented as part of a package (negative rates, quantitative easing (QE), and forward guidance) to raise inflation and reverse a fall in inflation expectations (2-year ahead expectations hit 1.2 percent by January 2015, below the 2 percent target).
- Table/Figure references and policy-rate panels reported: “Policy rates as of May 2016 (basis points).”

### Pass-through of policy rates to bank rates and wholesale funding costs
- Deposit rate stickiness:
  - Data point: interest rates on new deposit agreements declined but remained at or above zero even when policy rate became significantly negative.
  - Banks in Sweden refer to reaching a “zero floor.”
  - Sensitivity of retail deposit rates in Sweden to the repo rate appears to have declined after the latter dropped below 0.5 percent in July 2014.
- Lending rates:
  - Lending rates declined in both Denmark and Sweden, with a larger fall in Sweden.
  - Swedish new-loan interest rates declined broadly in parallel with the policy rate after February 2015.
  - In Denmark, pass-through to lending rates seems less pronounced on average after the -75 basis points cut; alternative DN (2016b) analysis shows lending rates for non-financial corporations and households followed the decline in the CD rate more closely.
- Aggregate lending-deposit margins:
  - Denmark: margins between bank lending and deposit rates averaged 1.5 percent between July 2012 and March 2016, in line with the mean in the three years before negative rates; margins have not hit the bottom seen during the global financial crisis.
  - Sweden: margins averaged 2.6 percent in 2011–14, but fell to just below 2 percent since February 2015 as deposit rate declines slowed relative to lending rate decreases.
- Wholesale funding and covered bonds:
  - Danish MB finance housing loans solely by issuing covered bonds under the “balance principle” and realize administrative fees from mortgage origination and servicing; increase in fees since negative rates contributed to solid MB margins.
  - Swedish banks rely heavily on non-deposit funding, including foreign currency funding swapped into SEK; funding structure noted: deposits and non-deposit funding sources at 48 and 52 percent, respectively.
  - Banks issue covered bonds in domestic and foreign currency and use interest rate swaps to hedge the interest rate risk between covered bonds and mortgages.
- Wholesale funding costs and pass-through:
  - Estimates of overall funding costs from covered bonds have continued to fall in line with the repo rate since the introduction of negative interest rates.
  - Pass-through from negative interest rates to money market rates and funding-cost estimates on covered bonds in SEK and Euro has been sizable since negative rates were introduced.
  - Taking account of shares of new covered bond issuance in domestic and foreign currency, decline in total funding cost on covered bonds closely matched the reduction in the repo rate since February 2015.
  - Reductions in wholesale funding costs since February 2015 have safeguarded bank margins despite deposit rate stickiness.
  - Note: “the use of non-core liabilities could raise financial stability concerns, since this type of funding is more unstable and prone to sharp reversals in time of crisis.”

### Banking in a negative interest rate environment (empirical observations)
- Data and sample:
  - Analysis uses unconsolidated financial statements for commercial banks (CB) and mortgage banks (MB) from Bankscope over 2005–15.
  - Sample includes 4 large CB from Denmark and Sweden, and 4 and 3 MB from Denmark and Sweden, respectively.
- Business models and balance-sheet structure:
  - CB offer broader products (unsecured and secured loans, overdrafts, investment products, checking accounts, term deposits); MB do not accept deposits and specialize in originating/servicing mortgage loans, earning spreads as loan servicing and origination fees.
  - Danish CB hold a notably larger portion of assets in securities (rather than loans) than Swedish CB.
  - In both countries, customer deposits account for less than half of funding, implying substantial use of wholesale funding sources.
  - MB in both Denmark and Sweden: almost all assets invested in mortgage loans and funding is primarily long-term.
- Credit trends and profits:
  - Denmark: CB lending has declined since 2008; MB lending slowed since 2012 due to subdued demand.
  - Sweden: lending continued to expand during 2015, supporting bank profits in Krona terms.
  - Profits:
    - Swedish MB profits continued upward trend in 2015.
    - Danish MB profits stable in 2012–14 then increased in 2015 when rates were most negative.
    - Danish CB registered strong results in 2015 after gradual decline in 2012–14.
    - Swedish CB profits slightly declined in 2015 but remained close to historic highs.
- Asset returns, funding costs, and net interest margins (2015 snapshot):
  - Charted measures indicate differences across Denmark CB, Sweden CB, Denmark MB, Sweden MB in asset return, funding cost, and net interest margin (values shown in Figure 7).
- Overall inference:
  - Controlling for asset growth, bank profitability has remained broadly stable since the introduction of negative interest rates (analysis continues in subsequent text).

*Source: _wp16198 - Section III discusses the pass-through of negative interest rates to bank rates and wholesale funding costs.*

### introduction of negative interest rates while it rose for MB in Sweden (Figure 9).

### _wp16198 - introduction of negative interest rates while it rose for MB in Sweden (Figure 9).

### Bank profitability and credit developments
- For banks in Denmark and CB in Sweden, net interest margins (NIM)—measured as net interest income to average earning assets—and net other income remained near their averages prior to the period of negative interest rates.
- MB profitability in Sweden rose since negative interest rates were introduced early 2015, maintaining their upward trend in recent years.
- Aggregate credit developments disguise differing underlying trends:
  - Commercial bank lending to households continued to be subdued in 2015 whereas it picked up in business banking.
  - There seems to have been a positive trend in credit growth in 2016 (DN, 2016b).
- The analysis abstracts from the effects of provisions on the bottom line since discretion in timing of provisions may mask the effect of negative interest rates on bank financial health (example: Danish banks achieved in 2015 the highest profit since the financial crisis at a time where the loan impairment charge ratio was substantially lower than the average over the last three decades (DN, 2016a)).

### Income structure and net interest margins (Figures 9–10)
- Pre-Provision Profit and Loan volumes shown for Danish and Swedish CB and MB (2005–2015) indicate differing dynamics across bank types and countries (charts summarized in text).
- Stable NIM are attributed to steady declines in bank interest expenses.
  - Interest income relative to assets declined for all banks in recent years, reflecting the strong pass-through from negative interest rates to lower lending rates.
  - Significant reduction in interest expenses, at historic lows in relation to earning assets.
  - Deposit rate declines have been limited during this period; interest expense reductions largely attributable to reduced costs from non-deposit funding.
- Specific drivers:
  - Reduction especially pronounced at MB in Sweden in 2015, owing to the combination of cheaper short-term funding and use of interest swaps on long-term funding.
  - Reduction was more gradual in Denmark.

### Net interest income components (Figure 10)
- Interest income and interest expense trends (2005–2015) show net interest income compression driven by lower interest income and, more importantly, lower interest expenses.
- Income structure charts for:
  - Danish CB: Net Interest income, Net Other Income, Pre-Provision Profit (percent of average earning assets).
  - Swedish CB: Net Interest income, Net Other Income, Pre-Provision Profit.
  - Danish MB and Swedish MB: Net Interest income dominant; net other income small relative to CBs.

### Net other income and fee dynamics (Figure 11)
- Net other income improved only slightly for CB whereas it was little changed for MB relative to recent years.
- Danish CB:
  - Raised substantially more income from fees and commissions during negative rate period, partly offset by higher non-interest expenses, giving limited improvement compared with typical levels prior to negative rates.
- Swedish CB:
  - Non-interest sources such as fund management and advisory services remained steady in 2015, with only a small improvement in net other income owing to reduced non-interest expenses.
- MB activities limited to mortgage lending:
  - Non-interest income and non-interest expense are less prominent; changes in net other income were small.

### Pre-provision ROE and bank equity/credit market reactions (Figures 12–14)
- Overall, no noticeable impact on banks’ bottom line following the introduction of negative interest rates.
  - Pre-provision return on equity (ROE) slightly declined for CBs in Denmark; remained flat for CB in Sweden after negative rates were introduced, albeit at a high level.
  - For MB:
    - Pre-provision ROE rose to its 2005 high in Denmark.
    - Strong upward trend in Sweden continued.
- Equity market performance since negative rates:
  - Since first introduction of negative rates in Denmark in July 2012, Danish bank equity prices persistently outperformed the OMX Copenhagen index and, as of September 2014, outpaced European banking stocks.
  - Swedish bank equities: returns broadly in line with Stockholm stock market index since rates turned negative, lower than European bank stocks until fall 2015; less affected by early-2016 volatility than European peers.
  - In four years since first introduction (January 2012), bank equity prices rose:
    - Denmark: 125 percent
    - Sweden: 76 percent
    - Euro area: 15 percent
    - UK: decline of 8 percent
    - Germany: decline of 28 percent
- Bank credit risk pricing:
  - Change in counterparty credit risk reflected in CDS spreads has been lowest in Denmark since first introduction of negative rates.
  - In Sweden, negative rate cuts do not seem to have had any impact on bank CDS spreads while spreads for banks from Germany, the U.K., and the broader EA spiked.
  - Recent rises in CDS spreads in Denmark and Sweden are driven by a broader repricing of bank credit risk.

### Key quantitative facts and metrics preserved from the source
- Repo rates averaged:
  - Sweden 2016: -0.5 percent
  - Sweden 2015: close to -0.25 percent
- Equity price changes since January 2012:
  - Denmark: 125 percent
  - Sweden: 76 percent
  - Euro area: 15 percent
  - UK: -8 percent
  - Germany: -28 percent
- EBA-based metrics (June 2015 / 2015H1):
  - Net fees and commission account for 22 percent of Danish banks’ earnings structure; Netherlands 15 percent; Sweden 29 percent.
  - Ratio of non-interest expense to operating income:
    - Sweden: 47 percent
    - Denmark: 50 percent
    - Germany: 74 percent
    - Netherlands: 53 percent
    - U.K.: 58 percent
  - Total capital ratios:
    - Danish banks: 20 percent
    - Swedish banks: 25 percent

### Analysis and interpretation
- Drivers limiting adverse profitability effects to date:
  - High reliance on non-deposit funding in Denmark and Sweden.
  - Sizable pass-through from negative policy interest rates to the cost of wholesale financing, which cut overall interest expenses to historically low levels.
  - Commercial bank profitability in Denmark cushioned by rising non-interest revenues from fee income (mortgage refinancing, corporate advisory), partially offset by higher non-interest expenses.
- Risks and potential future developments:
  - Full adverse impact on CB profits may remain to be observed because:
    - Policy rates only became significantly negative in 2015; loans with longer rate fixing periods may be repriced and maturing loans rolled over at lower prevailing rates in coming years.
    - Limits to banks’ ability to further increase non-interest revenues via fees.
    - Room for further cost reduction from interest expense compression could be restricted with deposit rates floored.
    - Signs of less than complete pass-through of negative rates into wholesale funding costs.
  - For Sweden:
    - High share of variable rate loans suggests a limited additional impact from further repricing, but greater impact is possible in 2016 with repo rates averaging -0.5 percent.
    - If foreign bond yields were to rise (e.g., reduced U.S. monetary stimulus), a rise in Swedish yields, including for covered bonds, may reduce the low-cost wholesale funding cushion for profitability.
  - Some offsetting rise in non-interest income (fees) may not be durable once loan refinancing is completed or due to competitive pressures.
  - An erosion of profitability would not soon threaten financial soundness, but extended profitability compression could pose risks to the quantity and quality of lending and therefore requires careful oversight.

### Policy implications and monitoring priorities
- Continue close monitoring of bank profitability indicators, including:
  - Net interest income and composition (interest income vs. interest expense).
  - Net other income components (fees & commissions, other non-interest income, non-interest expense).
  - Pre-provision return on equity and provisions trends to detect deferred loss recognition.
- Monitor funding cost dynamics and pass-through:
  - Wholesale funding costs and availability, including covered bond yields.
  - Deposit rate behavior and the extent of deposit rate stickiness.
- Watch for durability of non-interest revenue gains:
  - Fee income sources such as mortgage refinancing and advisory services may be temporary or subject to competitive pressures.
- Assess loan repricing timelines and exposure:
  - Share and maturity structure of loans with longer rate fixing periods.
  - Potential future repricing impacts on interest income as longer-term loans roll over.

*Italic: Source: _wp16198 - introduction of negative interest rates while it rose for MB in Sweden (Figure 9).*

### Box 2. Consolidated versus Unconsolidated Bank Accounts

### Box 2. Consolidated versus Unconsolidated Bank Accounts

### Main point
- Bank activities examined at the consolidated level may mask the effect of negative interest rates in domestic markets, particularly for banking groups that operate across borders or across diverse business segments.

### Illustrative examples and implications
- Danske Bank A/S:
  - Operates in 15 countries including Estonia, Latvia, Lithuania, Finland, Ireland, Norway, Sweden, and the U.K.
  - When examining consolidated financial statements of Danske Bank A/S, the effect of Danish negative interest rates may be masked by variations generated from the bank’s operations in foreign markets.
  - Footnote: While Danske Bank A/S (whose major foreign operations are in Sweden) is provided as an illustration to the general point that consolidated accounts do not reveal what happens at country level, most Danish banks have no or very limited operations in foreign countries.
- Nordea Bank AB (publ):
  - Operates both commercial and mortgage bank subsidiaries in each of Denmark (Nordea Bank Danmark A/S and Nordea Kredit Realkreditaktieselskab) and Sweden (Nordea Bank AB and Nordea Hypotek AB).
  - Consolidated financial statements do not permit assessment of how subsidiaries of a bank conglomerate operating in the same country but specializing in a different line of business (e.g., commercial banking and mortgage financing) are affected by negative rates.
- Universal banking model:
  - Covers diverse activities, including corporate banking, home finance, trading, private wealth management, leasing, and insurance.
  - Consolidated accounts do not reveal potential differences in the effect of negative rates across different business segments or across subsidiaries with different specializations.

### Consequences for analysis and supervision
- Consolidated-level analysis can obscure:
  - Country-specific impact of negative policy rates for cross-border banking groups.
  - Segment- or subsidiary-specific impacts within universal banking groups (e.g., commercial banking versus mortgage financing).
- Implication: To assess the effects of negative rates accurately, analysts and supervisors should consider unconsolidated (country- or business-segment-level) accounts alongside consolidated statements.

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### Appendix I. Cost of Funding from Covered Bonds in Sweden

### Overview of covered bond issuance and mortgage funding
- Swedish banks issue about 80 percent of their covered bonds in Swedish Krona and the rest in foreign currency mostly euro.
- Covered bonds finance long-term mortgages in SEK, where variable rate mortgages with fixation period of less than 3 months predominate.
- Footnote: 70 percent of housing loans have an original fixation period of less than 3 months in Sweden.

### Method to proxy cost of wholesale funding from covered bonds
- For SEK covered bonds:
  - Proxy cost = 3-month Stibor + cost of interest hedging.
  - Cost of interest hedging = difference between the yield on the SEK covered bond and that on the SEK interest rate swap of the same maturity.
- For EUR covered bonds:
  - Proxy cost = 3-month Euribor + interest hedging costs (EUR covered bond yield—EUR interest swap yield) + cost of a cross-currency basis swap SEK/EUR.
- Hedging treatment over time:
  - New hedging is contracted only for newly issued bonds; hedging costs for the portfolio of outstanding covered bonds estimated as a moving average consistent with average maturities:
    - SEK covered bonds: 3 years (moving average window).
    - EUR covered bonds: 2 years (moving average window).
- Overall funding cost:
  - The overall cost from covered bond funding is the weighted average of the funding in SEK and EUR, using the shares of new covered bond issuance as weights.

### Data and calculation notes (as presented)
- Cost of interest rate hedge is computed as a moving average of estimated credit spread (covered bond yield - interest rate swap yield) over 3 and 2-year windows for SEK and EUR covered bonds, respectively.
- Estimated funding cost on covered bonds in SEK:
  - 3-month Stibor + credit spread (SEK covered bond yield - SEK interest rate swap yield over Stibor) averaged over 3 years.
- Estimated funding cost on covered bonds in Euros:
  - 3-month Euribor + credit spread (EUR covered bond yield - EUR interest rate swap yield over Euribor) averaged over 2 years + cost of EUR/SWE FX swap.
- Sources cited for figures and calculations: Bloomberg, Haver, Statistics Sweden, and Fund staff calculations.

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### Appendix II. Commercial and Mortgage Banks Considered at the Unconsolidated Level
- Commercial Bank: Danske Bank A/S
- Mortgage Bank: Nordea Kredit Realkreditaktieselskab
- Commercial Bank: Nordea Bank AB (publ)
- Mortgage Bank: Nordea Hypotek AB (publ)
- Commercial Bank: Jyske Bank A/S
- Mortgage Bank: Nykredit Realkredit A/S
- Commercial Bank: Skandinaviska Enskilda Banken AB
- Mortgage Bank: Stadshypotek AB
- Commercial Bank: Nordea Bank Danmark A/S
- Mortgage Bank: Realkredit Danmark A/S
- Commercial Bank: Svenska Handelsbanken
- Mortgage Bank: Swedbank Hypotek AB
- Commercial Bank: Swedbank AB
- Mortgage Bank: Swedbank Mortgage AB
- Commercial Bank: Sydbank A/S
- Mortgage Bank: Totalkredit A/S

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### Appendix III. Banks Included in the EBA Dataset at the Highest Consolidated Level (selected entries shown)
- Germany: Landeskreditbank Baden-Württemberg–Förderbank; DekaBank Deutsche Girozentrale; Deutsche Bank AG; Commerzbank AG; Landesbank Baden-Württemberg; Landesbank Hessen-Thüringen Girozentrale; NORD/LB Norddeutsche Landesbank Girozentrale; WGZ BANK AG Westdeutsche Genossenschafts-Zentralbank; Aareal Bank AG; HSH Nordbank AG; Bayerische Landesbank; Deutsche Zentral-Genossenschaftsbank AG; HASPA Finanzholding; VW Financial Services AG; Landwirtschaftliche Rentenbank; Münchener Hypothekenbank eG; Hypo Real Estate Holding AG; Erwerbsgesellschaft der S-Finanzgruppe mbH & Co. KG; NRW.BANK, Düsseldorf; Deutsche Apotheker-und Ärztebank eG.
- Denmark: Jyske Bank; Sydbank; Nykredit Realkredit; Danske Bank.
- Finland: OP-Pohjola Group.
- Netherlands: N.V. Bank Nederlandse Gemeenten; ING Groep N.V.; SNS REAAL N.V.; ABN AMRO Groep N.V.; Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A.; Nederlandse Waterschapsbank N.V.
- Norway: DNB ASA.
- Sweden: Nordea Bank - group; Skandinaviska Enskilda Banken - group; Swedbank - group; Svenska Handelsbanken - group.
- United Kingdom: The Royal Bank of Scotland Group Public Limited Company; Lloyds Banking Group Plc; Barclays Plc; HSBC Holdings Plc.

*Source: Box 2 and Appendices I–III from the provided IMF content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16198.pdf_