The Council's working method
The Council's work concerning systemic risks is made up of three parts. The Council monitors the financial system, makes recommendations on policy measures and evaluates policy measures.
Part 1 – The Council monitors risks in the financial system as a whole
The Council takes stock of developments in the financial system every quarter. The Council reviews a diverse data set covering lending trends, the credit institutions' financing requirements, etc. The data set is used to illustrate a number of areas that may involve systemic risks. For example, increased risk appetite or overoptimism among lenders, firms and households may result in excessive growth in lending and leverage that could reinforce an upswing and the subsequent downturn. The risk areas are described in the memo Monitoring of systemic risks. The Council focuses on the financial system as a whole rather than individual institutions – unless the institutions affect the entire system due to their size or complexity.
The Council supplements the risk review with in-depth analyses of selected topics that may affect financial stability. The Council has taken a closer look at the impact on the financial system of financial obligations between Danish financial corporations, at the increased use of collateral in the form of repo transactions etc. and at cyber-attacks as a systemic threat, among other issues.
Part 2 – The Council makes recommendations on policy measures on a "comply-or-explain" basis
The Council issues recommendations regarding initiatives in the financial area that are to be taken well before a crisis may set in, so that systemic risks are prevented or the risks can be addressed. Alternatively, the Council may publish observations or warnings if closer monitoring is required, but specific policy measures are not yet needed. Specific crisis management initiatives and e.g. fiscal and tax policy are beyond the Council's mandate.
Since its establishment in 2013, the Council has issued four recommendations, one warning and two observations. The recommendations concerned restriction of deferred amortisation on mortgage loans, phasing-in of capital requirements legislation in Denmark, activation of the systemic risk buffer in the Faroe islands and limiting risky loan types at high level of indebtedness. The warning concerned systemic financial risk building up in the Faroe Islands. The observations concerned the low interest rates and the risk of systemic risks building up, since the very low interest rates may induce borrowers and financial players to assume excessive risk.
Each quarter, the Council assesses whether there is a need for policy measures. The Council issues a press release after each meeting, summarising the Council's risk assessment and outlining central discussions.
The Council conducts analyses of possible initiatives in order to prepare eventual future recommendations. For example, the Council has developed a method to assess the need for imposing countercyclical capital requirements in Denmark, also known as the countercyclical capital buffer. The method is a three-stage decision-making process. Initially, the Council assesses the development in a number of key indicators; then it takes into account other relevant information. Finally, the Council concludes what the appropriate level of the countercyclical buffer should be. The Council has also discussed other possible initiatives; see the overview. Other countries similar to Denmark are also in the process of building up expertise in preventing and limiting systemic risks.
Part 3 – The Council assesses whether policy measures are sufficient
The Council assesses how the government – or other recipients of a recommendation – follow up on recommended initiatives. Recommendations must either be implemented or the addressees must explain to the Council why a recommendation has not been complied with. As a main rule, both the recommendation and the eventual explanation will be made public. The Council's assessment must consider whether the follow-up is sufficient. The Council's assessment of the government's follow-up on its recommendations to phase in capital requirements and regarding mortgage loans with deferred amortisation is stated in the Council's press releases (see assessment of follow-up on phasing-in of capital requirements and assessment of follow-up on mortgage loans with deferred amortisation).