Financial Trends 2015

If the turnaround in the Norwegian economy proves moderate, with temporarily impaired growth, Norwegian banks can expect to see somewhat increased losses and reduced earnings, but not a dramatic impairment of their financial position. Even so, losses on individual exposures could be substantial.

- "In the event of a severe setback affecting the Norwegian economy on a broad front the banks could suffer heavy losses across several parts of their loan books," says Finanstilsynet's Director General, Morten Baltzersen.

The banks

Banks have recorded good profits in the years following the financial crisis. Earnings remain good thus far into 2015. Defaults and loan losses remain low, and banks have seen no need to increase their loss provisions to any appreciable degree. Capital adequacy has risen in the period since the financial crisis. The leverage ratio has however risen far less, and remains no higher than it was at the start of the 2000s. This is because growth in total assets has far outstripped growth in risk weighted assets.

Weaker growth in the Norwegian economy, high household indebtedness and the danger of imbalances in property markets call for banks to continue to improve their financial positions to enable them to grant credit to creditworthy customers in bad times. If not, the downturn could be exacerbated by a credit drought.

- "The banks must retain a significant portion of their profits to increase their common equity tier 1 capital ratios. This will require moderate dividend payouts," says Mr Baltzersen.

Households

Households' debt burden and house prices are at unprecedented levels. Because most residential mortgage loans carry a floating interest rate, an interest rate hike will rapidly lead to a large portion of borrowers' incomes being devoted to debt servicing. Many households are very heavily indebted relative to income and have small financial buffers. Despite slower economic growth, higher unemployment, lower real wage growth and generally heightened economic uncertainty due to the oil price fall, household debt growth has continued to outstrip growth in household incomes. Twelve-month growth in house prices slowed this autumn, but it is too early to say whether this reflects a turnaround in the housing market.

Lower borrowing rates and expectations of long-lasting low interest rates are an important reason for the above development. Real after-tax mortgage rates are now approximately zero. Although the turnaround in the Norwegian economy may in isolation dampen household demand, there is a danger that the rapid growth in household debt and house prices could last for some time. If it does, it will be more likely to trigger at some point a sudden turnaround in house prices and in household demand.

- "An abrupt and hefty financial consolidation of the household sector will have major ripple effects to the economy. Experience shows the consequences of economic shocks to have been greater in situations of high household debt and housing market imbalances," says Mr Baltzersen.

Finanstilsynet's home mortgage loan survey, based on a sample of recently granted mortgages, indicates a decline in the past year in the proportion of mortgages in excess of the maximum loan-to-value ratio of 85 per cent. A reduction is also noted in mortgages where the banks predict the borrower's inability to service their mortgage following a mortgage rate increase of 5 percentage points. However the survey shows the debt-to-income ratio, measured as debt relative to gross income, to be high, and particularly so in the case of young borrowers.

Life insurers and pension funds

The low interest rate level and prospects of low rates for a long period ahead pose a major challenge to pension providers. A significant portion of their liabilities comprises contracts carrying an annual guaranteed rate of return at a level in excess of the current market interest rate. Achieving sufficient return on pension assets in a low interest rate regime is difficult. Moreover, rising longevity requires higher technical provisions.

The introduction of Solvency II on 1 January 2016 will better reflect the risk inherent in the insurance business than previous solvency requirements. This will be particularly evident in the case of life insurers whose insurance liabilities under the new solvency regime will be recognised at market value. Given the current low interest rate level, this will in some respects entail a considerable increase in the value of their liabilities compared with the current regime. Life insurers are granted a transitional arrangement lasting 16 years in which to complete their technical provisioning. This will ease the solvency requirement for life insurers for a period, although there is no change in the underlying risk picture.