bring about the collapse of the euro. The euro is a common currency and, un- like a fixed exchange rate arrangement, capital flows cannot force a government to withdraw from the currency area. The euro zone can only break up if govern- ments take an explicit political decision about one or several countries leaving.
In the absence of such political decisions, the euro zone is stable.
In their support of Greece, policy leaders may also have acted from pure- ly national motives. A large proportion of the government bonds issued by Greece, Portugal and Spain is held by French and German banks. If Greece had decided to declare a suspension of its debt obligations, only a smaller pro- portion of these government bonds would have been covered, and it is likely that French and German banks would have needed further government sup- port. For political reasons, French and German policy-makers may have seen it as more convenient to support their domestic financial institutions in aiding Greece rather than providing new support through domestic channels.
THE BEHAVIOUR OF POLICY MAKERS:
eign investors might otherwise lose confidence in the Danish banking sector and that this would make it difficult for Danish banks to meet its large financ- ing need through the international wholesale markets. Thus, a prime motive for the Danish authorities’ intervention was to reassure international investors.
The large amount of foreign borrowing undertaken by banks thus seems to have created a situation in which government intervention to support ailing banks has become necessary.
The need to reassure foreign investors was made stronger by the Danish exchange rate policy, which is based on a fixed exchange rate parity against the euro. If foreign investors had stopped financing the Danish banks, a huge government borrowing abroad would have been necessary to make up for the shortfall in capital inflows. If it had not been possible at short notice to achieve such a massive government borrowing abroad, a currency crisis would have been the result, possibly making it necessary to abandon the fixed exchange rate against the euro.
The guarantee scheme for the debt obligations of the banks has affected foreign countries negatively because the scheme has attracted capital inflows to Denmark at the expense of capital flows to other countries. The Danish authorities were among the first to participate in the competition to attract funding. The Irish guarantee scheme was introduced on 30 September 2008.
The Danish state guarantee scheme was proposed as early as 8 October 2008 and signed into law after an emergency procedure in the Danish Parliament on 10 October 2008. Denmark was thus among the first countries to introduce a guarantee scheme.
The Danish system of capital injections in banks can be seen as non-discrim- inatory in the sense that the scheme is open to all banks registered in Denmark, including foreign-owned banks. As the preferred shares can be converted into common equity, the scheme enhances the likelihood of a bank’s survival and thus also involves a significant strengthening of the security behind the sub- ordinated capital which had previously been invested in it. This subordinated capital had to a large extent been supplied by foreign investors. The scheme includes provisions that oblige a bank to use the public capital injection as far as possible to improve its solvency and which require the bank not to erode its capital base by making transfers to other companies in the group, e.g. to a foreign parent company. However, a bank may use the public capital injection
to increase the capital base of its subsidiaries. This means that a Danish bank can use the public capital injection to increase the capital base of, for example, subsidiaries in Finland and in Northern Ireland, thus keeping credit flows open in these countries too.
By establishing a system of capital injections in banks, the Danish au- thorities intended to maintain credit flows for resident households and non- financial enterprises. This aim might alternatively have been achieved if the government had established a scheme which directly supplied loans to Dan- ish households and non-financial enterprises. It is remarkable that the Danish government chose not to use this option but instead chose capital injections which could also be used to bolster Danish banks’ lending in foreign countries.
It is also remarkable that the Danish scheme does not include any conditions that the recipient banks should maintain lending to Danish residents. The only condition posed by the authorities for the injection of public capital is that the banks should submit a report every six months to cover developments in the banks’ lending practices; there is no requirement that banks must specifi- cally report on lending practices or in the development of lending to Danish residents.
In summary, it seems that, in its implementation of the bank rescue opera- tions, the Danish government – broadly supported by the other political par- ties – to a large extent downplayed the country’s national interests. Thus, the rescue schemes have had the effect of promoting lending not only in Denmark but also in other countries where Danish banks have activities. If the Danish government had only wanted to encourage lending to Danish residents, other types of intervention could have been used. The government could, for exam- ple, have chosen to provide public loans directly to Danish non-financial enter- prises and households. The authorities could also have made it a condition that, in return for receiving injections of public capital, the banks would maintain lending for Danish residents.
In February 2010, the Social Democratic opposition complained that the injection of public capital into the Danish banking sector could be used to sustain lending in countries other than Denmark. This was rejected by the min- ister of economics and business affairs, whose ministry will nonetheless now conduct an investigation into how the scheme of public capital injections has affected lending to Danish residents.
In the Greek rescue operation, the Danish government volunteered to guarantee some of the loans which were made available for euro-zone coun- tries. The Danish decision to participate was made even though Denmark, not being in the euro zone, is not entitled to receive any of the loans which are made available through the facility. As the Danish contribution makes little difference to the overall size of the total package, the decision can be seen as another indication that European policy-makers increasingly act not only to optimise the interests of their national constituencies, but also with a view to optimising non-national interests.