The Norwegian economy is sound, and Norwegian banks are solid and profitable. This puts the Norwegian economy in a good position to withstand the impact of international financial turbulence and a weaker trend in the world economy. Renewed turmoil in international financial markets will affect Norwegian banks' funding opportunities and life insurers' rates of return may be impaired. A substantial international setback will hit Norwegian business and industry, which could increase banks' loan losses.
Banks' capital adequacy improved, but further strengthening of financial positions needed
Continued low loan losses are a factor behind banks' good performances. Norwegian banks have increased their capital ratios in the past year. Finanstilsynet wants all Norwegian banks and finance companies to have a common equity tier 1 ratio of at least 9 per cent by the end-June 2012.
- The uncertainty in the economy and markets and increased requirements from authorities and markets call for further strengthening of banks' financial positions. It is important that banks exploit their good performances to build up reserves so that they are well positioned to meet increased losses in bad times, says Finanstilsynet's Director General, Morten Baltzersen.
Norwegian banks obtain much of their funding in international money and capital markets. Markets conditions are liable to change rapidly, and banks need to be prepared for situations in which funding may be a problem. In recent years banks have improved their funding thanks to longer maturities on loans and expanded liquidity buffers. However, funding needs to be made even more robust.
House prices and household debt continue to grow
High house prices and heavy household indebtedness pose a risk to the stability of the Norwegian economy and financial sector. Banks appear to be aiming to continue their rapid expansion in the retail market ahead. There is a danger that banks individually underestimate the systemic risk associated with such expansion. Continued strong growth in house prices and household debt could well be followed by a significant setback which will impact on a broad front and produce substantial knock-on effects in the economy.
In March 2010 Finanstilsynet established guidelines for prudent home mortgage lending practice on the part of banks. In light of the development of house prices and household debt the guidelines were tightened in December 2011. Finanstilsynet has monitored banks' compliance with the guidelines both through on-site inspections and surveys. Banks are largely in compliance, but there is still room for improvement.
In Finanstilsynet's assessment the mortgage lending guidelines have contributed to a more level-headed approach to lending on the part of banks. The volume of loans carrying high loan-to-value ratios has fallen. However, the survey also shows that many households, especially younger ones, are taking out sizeable loans.
- The trend in house prices and household borrowing continues to give cause for concern, says Mr Baltzersen.
The growth in household debt is driven by high demand. In periods of heavy credit demand it is particularly important for banks to apply level-headed credit assessments that safeguard long-term considerations for the borrower, the individual bank and the banking system alike. All the same, measures to support sound lending practices can only limitedly mitigate demand-side effects on debt growth," says Morten Baltzersen.
Covered bonds
The financial crisis exposed a major need for more robust funding among Norwegian banks. Covered bond issuance has been an important means to this end since it has provided banks with better access to long-term funding in turbulent financial markets. Use of such bonds has also risen internationally, reflecting increased risk aversion in international lending markets.
Although the emergence of the covered bond market has been important for Norwegian banks' funding, it also poses challenges. When the presumptively best secured loans on banks' balance sheets are mortgaged, banks' other creditors, who are unsecured or lack a deposit guarantee, perceive an increased credit risk. As a result banks may in time experience problems in obtaining funding other than by covered bonds, which may in turn heighten vulnerability and reduce their ability to finance loans carrying higher credit risk than home loans.
Banks' funding opportunities are likely to be vulnerable to changing economic conditions. In periods of rising house prices and demand for home loans, banks have ready access to funding through covered bonds. In downturns accompanied by falling house prices, this funding source may rapidly dry up at the same time as other funding opportunities are weakened because the best loans have been mortgaged. Hence covered bonds may add a detrimental, procyclical element to banks' funding and lending.
The fact that home loans can be funded at significantly lower interest rates through covered bonds than is the case with loans to business and industry may, detrimentally, draw bank lending away from businesses towards households.
The strong emergence of secured bank funding internationally has led to growing disquiet among authorities in many countries. A number of countries have set limits to this source of funding.
- Although covered bonds have made a positive contribution to Norwegian banks' funding in a period of international financial turbulence, consideration should now be given to possibly curbing the use of such bonds, says Mr Baltzersen.
If general restrictions are to be introduced, this must be done in a way that does not undermine the established market for covered bonds. Regardless of possible general restrictions, Finanstilsynet will focus on the use made of covered bonds when assessing the individual bank's risk and capital need.
Major challenges to life insurers
Despite weak prospects of economic growth, stock markets have proven relatively bullish thus far in 2012, boosting life insurers' financial earnings. First-half results were therefore good, and buffer capital rose. The stock market trend ahead is highly uncertain. If insurers are to be in a position to meet fluctuating share prices, buffer capital needs to be further strengthened.
Low long interest rates, the uncertainty in stock markets and increased longevity represent major challenges to life insurers ahead. It is important that life insurers expand their equity capital, both in order to strengthen their risk bearing capacity and to meet forthcoming requirements under the Solvency II regime.
Consumer protection
In 2012 Finanstilsynet has conducted several thematic inspections as part of its consumer protection remit in the financial sphere. It has surveyed life insurers’ information and advice when selling savings products, insurance agents’ commission arrangements when selling non-life insurance, and banks’ marketing of complex products. Supervision of banks compliance with the home loan guidelines also has a basis in consumer protection.
Thus far in 2012 Finanstilsynet has resolved to withdraw the licences of two investment firms, in one case after breach of the conduct of business rules. These decisions have been appealed to the Ministry of Finance and will not be enforced until a ruling has been made on the appeals.
In the course of 2012 Finanstilsynet has asked 25 banks for an evaluation of their product packages' compliance with relevant regulations. Most banks halted or revised their product packages (tied and/or bundled) following Finanstilsynet's initial approach. Finanstilsynet considers that the banks have insufficiently documented and described cost savings on cross sales that qualify for exemption from the prohibition against product packages. Finanstilsynet has in six instances instructed banks to halt their marketing and sale of product packages.