Good profit performances and satisfactory financial positions on the part of Norwegian banks, but considerable uncertainty prevails

This emerges in "Financial Outlook 2011", a report presented by Finanstilsynet at its press conference on 10 March 2011.

Several euro countries and the US are running substantial public budget deficits, and a further increase in public indebtedness is anticipated in 2011 in spite of tightening action. The Middle East and North Africa are in a turbulent state.  Prices of commodities, above all of oil, metals and food products rose steeply in 2010 and have continued to do so thus far in 2011.

• Rising commodity prices and quickening inflation in the industrialised world could lead to steeper international interest rate hikes in the 12 to 18 months ahead than previously expected, says Finanstilsynet's Director General Bjørn Skogstad Aamo.

Banks had ample access to fairly favourably priced funding in 2010 thanks both to the market confidence enjoyed by Norwegian banks and to investors’ interest in covered bonds. However, this favourable situation could rapidly change should a negative international trend spark increased uncertainty in the markets.

• It is important that banks continue their effort to put their funding on a longer-term footing and that liquidity buffers are established able to curb the consequences of a possible liquidity crisis. Finanstilsynet is keeping a close watch on the banks' adjustment to new international liquidity requirements, partly through a new reporting regime in place in 2011, says Mr Skogstad Aamo.

Relatively strong growth is expected in Norway's mainland (non-oil) GDP. The expansion appears to be broad-based and there is concern that the Norwegian economy is in danger of overheating. Norwegian house prices are rising rapidly. Norwegian households’ debt burden is at an unprecedented level, also when compared with that of other countries. Household debt is rising more rapidly than incomes, and the proportion of very heavily indebted households is on the increase. For a sizeable proportion of home mortgage loans the amounts borrowed are still very high relative to property value. These factors, combined with smaller repayments and a very high level of floating rate mortgages, render households vulnerable to interest rate hikes.

A survey carried out by Statistics Norway on behalf of Finanstilsynet shows that if the interest paid by households at the end of 2012 returns to the 2008 level, 440,000 households will see interest rate expenses in excess of 20% of disposable income.

The rise in house prices could be succeeded by a decline causing the house price bubble to burst if households' ability and willingness to demand dwellings at higher prices is threatened either by economic disturbances that weaken employment or if interest rates rise substantially higher than many assumed when taking out their mortgage.

• “In the interest of limiting the risk of a house price bubble build-up, it is important not to wait too long before the gradual normalisation of interest rates signalled by Norges Bank is put into effect. Finanstilsynet is monitoring banks’ compliance with the guidelines for good home mortgage lending practices through active on-site inspections,” emphasises Mr Skogstad Aamo, who points out that stricter regulation of lending is a possibility that may be considered.

Financial Outlook states Finanstilsynet’s view that the pace of implementation of the new international capital requirements should be discussed in the Nordic context. Implementing a countercyclical capital buffer designed to curb excessive lending growth with a basis in a new international body of rules can only be considered from 2013 onwards. Further bolstering of banks’ equity in 2011 and 2012 must as previously build on the dialogue between the banks and Finanstilsynet with a basis in Pillar 2 of the Basel II framework which empowers Finanstilsynet to impose on the banks capital requirements higher than the statutory minimum.

At the press conference Mr Skogstad Aamo announced that Norway is now playing an active role in the new European Supervisory Authorities, participating for example in the comprehensive stress test on European banks under preparation by the European Banking Authority. Of Norwegian banks, DnB NOR will be covered by the test.