A high activity level in the Norwegian economy contributed to good results for Norwegian banks in 2013. Loan losses are still low, but the banks must be prepared for the possibility of increased losses in the next few years. Much uncertainty attends the international economy, which is still affected by financial imbalances. Household debt is growing faster than household incomes, and households will be vulnerable in the event of income decline and higher interest rates. Banks' financial position strengthened in 2013, but Norwegian banks need to further bolster their equity capital position to tackle economic uncertainty and forthcoming regulatory requirements.
The oil price has held up high, contributing to a high activity level in Norway. Growth in the Norwegian economy is expected to pick up, but the prospects are uncertain. Lower growth in the world economy could bring a significantly lower oil price, and households' high leverage may lead to falling private consumption and housing investments.
In 2013, as previously, household debt growth outstripped household income growth, bringing the ratio of debt to incomes to a historically high level. Many households are heavily indebted and particularly vulnerable. Household debt and house prices are closely related. A flattening of house prices will gradually bring lower debt growth and lessens the danger of a serious setback. However, developments ahead are uncertain. After a brief period of decline last autumn, house prices have again risen in the first three months of 2014.
"Should the Norwegian economy prove significantly weaker than expected, it is important to have solid, profitable banks that are able to provide credit to creditworthy customers in bad times as in good," says Finanstilsynet's director general, Morten Baltzersen.
New capital and buffer requirements
In 2013 the government established new capital and buffer requirements for Norwegian banks with a basis in new requirements in the EU. The Norwegian buffer requirements are to be gradually stepped up in the period to 1 July 2016. The requirements are well adapted to a balanced development of the Norwegian economy. Stress tests conducted by Finanstilsynet confirm the need to strengthen banks' financial soundness in the years ahead.
"Given continued good earnings, moderate lending growth and modest dividend payouts, Finanstilsynet calculations show that the requirements will broadly be met by profit retention," says Mr Baltzersen.
Society stands to make large savings by reducing the likelihood of future financial crises. The increased capital requirements make the banks more robust, and counteract banks' incentives to assume excessive risk. Sound finances will contribute to more favourable funding terms for the banks. Once the banks become more robust, equity return requirements and risk premiums on banks' external funding will fall.
Norwegian government authorities consider it important that all banks in Norway should be subject to capital adequacy requirements that are as uniform as possible, regardless of whether they are Norwegian banks or branches of foreign entities. At the same time the capital requirements must be robust and adapted to conditions specific to Norway. Finanstilsynet will therefore utilise the scope given by the EEA rules to strengthen banks' financial soundness, liquidity and funding.
Finanstilsynet has announced a tightening in the home mortgage loan models, based on an assessment of the housing market and mortgage weights used in the IRB models. This comes in addition to the tightening adopted by the Ministry of Finance with effect from 1 January 2014. Through its collaboration with other Nordic supervisory authorities, Finanstilsynet has requested that Finanstilsynet's measure to increase the risk weights on Norwegian mortgages should be applied to all Nordic banks. The Swedish and Danish supervisory authorities have confirmed that the tightening action will also be given effect for all Swedish and Danish banks' business in Norway.
In the years ahead the banks will face tighter requirements on their liquidity positions and long-term funding. Norwegian banks still largely obtain their funding in international capital markets. Banks enjoy ample access to international loan markets, and market funding is now on a longer-term footing, thanks in particular to increased issuance of covered bonds. However, funding in international capital markets is vulnerable in the event of international turbulence, as witnessed during the financial crisis. Heavy dependence on funding backed by banks' mortgage loans may also lead to vulnerability, for example in the event of house price falls. Banks must therefore continue their effort to assure more robust funding and improved liquidity.
Life insurers and pension funds
Results posted by life insurers and pension funds (pension providers) were relatively sound in 2013, with value adjusted return on capital of, respectively, 5.9 per cent and over 10 per cent. The main contributor was the stock market recovery. At the same time the uncertainty in the world economy creates nervousness among investors, and could prompt a rise in risk premiums on fixed income securities and a fall in share prices. Large portions of pension providers' profits need to be devoted to strengthening financial positions up to the introduction of new international solvency rules, effective as from 1 January 2016. At the same time, rising longevity and new mortality tables for life insurers and pension funds require a substantial increase in premium reserves.
In Finanstilsynet's assessment, insured persons' pension claims are best secured by allowing pension providers a period in which to adjust to new provisioning requirements resulting from the new mortality tables. A large portion of the need for increased technical provisions must be met by policyholders' surplus, but pension providers themselves need to meet at least 20 per cent. Finanstilsynet has written to pension providers to make it clear that it is only the surplus on the individual contract that is to be used to strengthen that contract's premium reserve so long as it is under-provisioned, and that pension providers' minimum contribution of 20 per cent is to be added at contract level. Pension providers will be allowed to apply for a step-up period of up to 7 years. About one half of the overall need for increased provisioning has been met through allocation of policyholders' surplus achieved in 2011-2013.