Basel II and lending policies of Danish banks under on-going economic crisis

Olga Kontogeorgis

Student thesis: Master thesis

Abstract

The introduction of Basel II in 2006 was part of the framework on how global markets and institutions can better serve the needs of people in different countries. Unfortunately, the beginning of the Basel II implementation practically coincided with a recent so-called Subprime mortgage crisis (SMC) that started in USA in 2007 and affected later economies worldwide. This fact raised debate on whether Basel II has been released too late and whether it is not a solution to a crisis but instead maybe even its cause. The idea of this project is to investigate how Basel II affected the Danish banking system, in particular lending policies of the Danish banks. The Basel II has been introduced in the Danish legislation since 2007. In our research we take also into consideration the influence of the on-going international financial crisis, started in 2007, on the Danish banking sector. This work was inspired by the published research of Ruthenberg and Landskroner (2008) who formulated a model for loan pricing under Basel II and made an empirical analysis based on the data from one of the largest banks in Israel. In our research, based on the Danish economy data, we focus on the following research questions:  Is the published model valid in the case of the Danish economy?  Which was the influence of Basel II and the on-going economic crisis on the Danish banking sector?  How did the introduction of the Basel II affect the competition between Danish banks? Methods of the industrial organization and econometric analysis are applied in this thesis, thus differentiating this work from the other projects recently carried at Copenhagen Business School on Basel II. Although the published article presented a forecasting model on loan pricing under Basel II with exiting results, a number of difficulties appeared after its thorough reading. The mathematical model had to be corrected, and data used in some cases by authors was a little confusing. A regression model here was formulated in a similar way, and credible data used for econometric analysis was retrieved from the publicly available databases of the National Bank of Denmark, Danish FSA (Finanstilsynet), NASDAQUE OMX Group and Denmark Statistics. The cases of loans to non-financial companies of different maturity: a) up to 1 year; b) 1 to 5 years and c) over 5 years have been considered. Our results showed that although most of the regression coefficients were significantly different from zero for cases of the loans with different maturities, the estimated coefficients for the cost of equity sensitivity (the Basel II related term) were received insignificantly different from zero. A detected evidence of the positive autocorrelation brought us to the conclusion that our model based on published research cannot be used as a forecasting model on loan pricing under Basel II in the case of the Danish economy. The other conclusion was that lending policies of the Danish banks in 2007-2009 were significantly affected by on-going crisis and political decisions, much more than by the implementation of the Basel II. The conclusion on competition from the published research may still be applicable to the case of the Danish banking sector: low risk highly quality customers will be attracted by schemes of the large Danish banks, while more risky customers will obtain loans from the small banks (which use the standardized approach).

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2010
Number of pages87