Risk Outlook – December 2023

Overall, economic activity in Norway has remained high through 2023, and unemployment is low. This is reflected in low loan losses in the banks. Combined with an increase in net interest income, the low losses have contributed to high profits. The higher interest rate level has also improved life insurers’ solvency position.

Future developments are highly uncertain.

“Experience from Norway and other countries shows that crises in the financial system can occur suddenly and spread rapidly among market participants, both nationally and internationally. An international downturn could lead to financial market turbulence and increase the risk of financial instability, also in Norway. Norwegian banks and insurers could thus be severely affected,” says Finanstilsynet’s Director General, Per Mathis Kongsrud.

High debt in Norwegian households and elevated residential and commercial property prices are the key vulnerabilities in the Norwegian financial system.

Households

Norwegian households have high debt relative to income. Lower credit growth and higher nominal income growth have contributed to a certain reduction in the debt burden over the past year. Finanstilsynet's residential mortgage lending survey from autumn 2023 also shows a decline in the average debt-to-income (DTI) ratio of borrowers who took out new debt and a reduction in the share of loans granted to borrowers with high DTI ratios.

“Norwegian households have the highest debt burden in the OECD area, and many borrowers have high total debt. Households’ interest burden has increased significantly. Many households with high debt are vulnerable to a further rise in interest rates, loss of income or declining house prices,” says Per Mathis Kongsrud.

Households’ demand may decline, and their debt servicing capacity may be further impaired in the coming period, especially if economic developments prove to be weaker or interest rates higher than expected.

House prices

There has been strong growth in house prices over a protracted period. Although the rate of growth has slowed, prices are at a high level relative to households’ disposable income. Experience from Norway and other countries shows that periods of rapid house price growth may be succeeded by a sharp drop in prices which amplifies and prolongs an economic downturn. The risk of such a development is greater if interest rates have to be kept high for longer than expected or be further increased. Lower house prices reduce banks' collateral values.

Commercial real estate

Higher interest rates have led to a fall in the value of commercial properties and reduced earnings in commercial real estate (CRE) companies. A number of these companies have high debt, and a substantial share of their debt matures and must be refinanced in the coming years. The share of

debt in CRE companies with weak interest servicing capacity has increased markedly. If interest rates remain high, the share of high-risk debt may increase further and elevate banks’ credit risk.

Banks

Equity capital is crucial for banks' risk-bearing capacity and their ability to extend new loans to creditworthy customers during economic downturns. During severe downturns, banks in Norway and internationally have recorded substantial losses on loans, including loans secured on commercial real estate. If large losses were to occur and it becomes necessary to draw on capital buffers, experience shows that banks can rapidly lose market confidence and experience liquidity problems. Norwegian banks should therefore meet regulatory requirements by an ample margin.

“Due to their high level of profitability, Norwegian banks are in a good position to increase their capital adequacy ratios. This will improve the banks' capacity to provide loans to creditworthy customers in periods of higher loan losses. Finanstilsynet expects Norwegian banks to thoroughly assess the risk in their loan portfolios and the need for impairment losses, and to apply caution with respect to dividend payments and share buybacks,” says Kongsrud.

Insurers and pension funds

Norwegian insurers and pension funds meet prevailing solvency capital requirements. The fall in CRE prices and weaker earnings in CRE companies have a particularly negative impact on Norwegian life insurers. Overall, life insurers have a higher exposure to real estate than corresponding undertakings in most other European countries. For non-life insurers, more extreme weather coupled with a more challenging reinsurance market entail weaker earnings prospects and heightened risk in the coming period.