The Danish Risk Council has given a strong warning that sudden changes in how the markets view risk could lead to big falls in asset prices and fire sales.
The council, chaired by the director of the Danish central bank Lars Rohde, said after its latest quarterly meeting: “Sudden changes in risk perception in the financial markets combined with low market liquidity may still lead to significant falls in asset prices and fire sales.”
It warned about behaviour that could be unleashed by the availability of cheap credit.
“Due caution should be exerted in relation to the low level of interest rates, which may lead to excessive risk-taking and risk illusion among borrowers and credit institutions,” the council said.
The Danish Risk Council was set up in 2013 by the country’s government to address systemic risks in the financial sphere.
In its statement, the council said that, in the last few months, the risk of a rapid and marked fall in asset prices in some of the global financial markets had appeared to some extent.
“The large fluctuations in the financial markets in early 2016 have not had systemic consequences in Denmark,” it said, but it warned that sudden changes in the perception of risk could prompt big asset price falls.
Seasonally adjusted prices in the housing market continued to rise in the second half of last year, it said, even though this was at a more moderate pace than in the first half for single-family houses.
Expectations of future price developments remains high, it said.
“While growth in housing loans in Copenhagen and Aarhus has subsided, market expectations of low interest rates several years ahead may still lead to excessive risk-taking and risk illusion among borrowers and credit institutions,” the council said.
It said this could be the case if the risks of higher interest rates and a reversal in house prices were not taken into account to a sufficient degree.
The council said the observation it made in March last year about low interest rates and the build-up of systemic risks still applied.
Back then, it said the conditions for a rapid build-up of systemic financial risks were in place due to the extraordinarily low interest rates, especially if these were “embedded into the expectations of borrowers and credit institutions”.
The council said yesterday that it also discussed potential systemic risks stemming from the insurance and pension fund sectors at its latest meeting.
“The Council considers it crucial that companies be appropriately capitalised to avoid fire sales in periods of sudden changes in asset prices,” it said, adding that it would continue the analysis of systemic risks in the insurance and pension fund sectors.
Meanwhile, in its regulation statistics publications, the Danish central bank (Danmarks Nationalbank) reported that, even though interest rates on overnight deposits remain negative in Denmark, companies in the country are still putting more money into banks.
It said the average interest rate for the overnight deposits had been negative since April 2015 but that deposits grew in February by DKK21bn (€2.8bn) to stand at DKK218bn at the end of the month.
“Overnight deposits account for more than 94% of total corporate deposits, while time deposits account for an ever smaller proportion, even though the interest rate on these is still positive, albeit declining,” the central bank said.
The average interest rate on all overnight deposits for business was just below zero in February.
The bank said the insurance and pension sector, as well as unit trusts, were now getting the lowest average deposit interest rates at around -0.6% on their total deposits.