COPENHAGEN: Danske Bank A/S has been dealing with negative interest rates longer than any other major bank. That’s why its latest crisis, which cost a top executive his job, carries an important warning for its peers in Europe.

Denmark’s biggest bank is best known for its role at the center of a vast money laundering scandal. But last month, it got caught in another embarrassment, namely overcharging retail clients for investment products and causing them to lose money. 

The bank should have followed rules that stipulate investment advice must always guide clients to the best product, even if that goes against the bank’s interests. In this case, clients would have been better off in regular bank deposits, where returns are around zero.

The problem for Danske, and other banks operating in negative-rate environments, is that the more money they hold in deposits, the greater the cost to the bank. The industry has balked at passing on the cost of negative rates to retail savers, for fear of losing business. Instead, banks have looked for other ways to mitigate the pain of negative rates, such as focusing on services that require fees.

Jesper Berg, the director general of the Financial Supervisory Authority in Copenhagen, says that the Danske case now "shows that the fee channel is also threatened” for banks dealing with negative rates.

The Last Bright Spot

Fee income was one of the last bright spots for an industry that has watched negative rates erode many of its other key business areas.

In the past, banks would "make money from getting cheaper [deposit] funding than market funding: That channel throughout Europe is dead,” Berg said. They would also make money by taking short-term duration risks, "but the yield curve is flat right now, or in that neighborhood, so they don’t get that 1% or 2% which they historically got on doing that sort of business.” And now, negative rates are eating into fee income, he said.

Go back a few years, and the narrative was that Danske had successfully adapted its business model to cope with negative rates. It delivered record profits in 2017, when Denmark had already had interest rates below zero for roughly half a decade. That was also the year that Danske raised fees for customers who put money into an investment platform called Flexinvest Fri.

But the returns on some of those products were low. By the time the higher fees were included, clients were losing money. The bank nevertheless recommended the product and collected the fees. It shouldn’t have, given regulations that require banks always to act in their clients’ interest.

The kind of fees Danske was charging constitute "a significant part of fee income in many banks across Europe,” Berg said. "If that is threatened, there is a more generic issue across Europe.”

As the prospect of returning to positive interest rates in Europe seems more remote, the impact of the policy on the region’s banks warrants attention. In Denmark, finance industry profits were down 25% in 2018, according to FSA data. Berg says his agency is now starting to worry about profitability among banks.

"Typically the issue has been, we lean against the wind because of bubbles,” he said. "But now it is an issue of the earnings power of banks.”

Meanwhile, Danske continues to face fines potentially in the billions of dollars for its Estonian money laundering scandal. On Thursday, newspaper Berlingske reported that an existing investigation into the bank has been expanded to include its decision in 2014 to fire a company it had hired to examine warnings by a whistleblower.

Since the beginning of last year, shares in Danske Bank have plunged by about 57% as shareholders have reacted to its scandals. - Bloomberg