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* Proposal is a step in the right direction -S&P
* Plan does not neutralise risk from short-term funding -S&P (Adds details, background, quotes)
By Teis Jensen
COPENHAGEN, Feb 5 (Reuters) - The Danish government's proposals to tackle problems banks face when they refinance adjustable-rate mortgage bonds do not fully eliminate the risks, credit rating agency Standard & Poor's said on Wednesday.
S&P said the proposals were a step in the right direction. "But they fall short of neutralising the risk from the banks' heavy reliance on short-term funding," it said in a note.
Denmark has the third-biggest covered bond market in the world after the United States and Germany. Covered bonds are used by banks to finance home loans. Credit rating agencies and the European Commision have raised concerns about them, saying banks are at risk should international debt markets freeze up.
In Denmark, the bonds are refinanced at large auctions every year, when around 930 billion Danish crowns ($170 billion) worth of one-year adjustable rate mortgage bonds are sold.
To cut the mortgage banks' refinancing risk, the government has proposed that if an auction fails, or produces an interest rate more than 5 percentage points higher than the rate the bond originally offered, then the bond would be extended by 12 months at a time.
"In our view, the proposal is a step in the right direction," S&P said. "However, we don't believe it fully addresses the fundamental issue of mortgage lenders' significant annual refinancing needs."
S&P lowered its outlook for Denmark's largest bank Danske Bank's rating to stable from positive in July due to the funding risks at the auctions. S&P's latest note does note include any changes in ratings or outlooks.
Political sources told Reuters last month the Danish lawmakers were close to agreeing on the proposal, which was first announced in November, and which is planned to come in to effect from April 1.
The two other major rating agencies Moody's and Fitch have said that the proposed bill would reduce the refinancing risks for the mortgage banks. (Editing by Andrew Heavens. Editing by Jane Merriman)