The level of debt in Norway is high relative to total production, and has never been higher than at present. Household debt in particular has grown by a wide margin relative to incomes. Concurrently house prices have risen sharply. After briefly levelling off in 2013, house price growth has again gathered momentum.
The growth in house prices and household debt is primarily demand driven. Low interest rates, low housing taxes, low unemployment, high real income growth and migration to central areas are important explanatory factors. However, conditions on the supply side of the credit market have also contributed to the growth in debt and house prices. Competition in the mortgage market is strong, with ready access to credit. Finanstilsynet’s autumn 2014 mortgage survey and other information gained from supervision suggest that the banks have eased their credit practices in the past year. Norges Bank’s loan surveys suggest the same.
Although the oil price fall has so far had little impact on output and employment, a substantial, lasting fall in the oil price could have major negative effects for the Norwegian economy. Petroleum activities and suppliers to this sector are of major significance to the mainland (non-oil) economy.
A weaker outlook and increased uncertainty for the Norwegian economy will in isolation contribute to dampening households’ propensity to borrow.
- However, there is a danger that the prospect of a long period of low interest rates and ample access to credit will encourage continued strong growth in debt and house prices. This will further increase households’ debt burden and contribute to maintaining demand for goods and services for a period, but such a development is not sustainable. The risk of a subsequent hefty setback and financial instability will in that event increase, says Finanstilsynet's director general, Morten Baltzersen
Financially sound banks are crucial to the Norwegian economy’s ability to tackle an economic downturn. Banks must build up capital when profits are good, as they have been in recent years. Increased capital makes banks more robust in a downturn, putting them in a position to grant new loans to creditworthy borrowers. Norwegian banks recorded substantial net profits in 2014, the bulk of which were retained to increase their equity capital.
- Developments in the housing and credit markets have increased the risk of financial instability. This underscores how important it is for banks to continue to improve their financial position by retaining the bulk of their net profit, says Mr Baltzersen.
The effect on credit and house prices of increased capital requirements, whether they are requirements of a general nature or applied to specific types of loan, is probably limited, particularly in times of rapid credit growth and household optimism. Other policy instruments are better suited to dampening the growth in house prices and credit to households. In recent years many countries have applied instruments such as maximum loan-to-value ratios (debt relative to property value) and maximum debt-servicing capacity ratios (income relative to debt and liquidity burden), requirements on maximum loan term and requirements on annual amortisation instalments to limit the supply of housing credit and curb households’ debt burden.
In its letter to the Ministry of Finance of 16 March 2015, Finanstilsynet proposes enshrining requirements on banks’ mortgage lending practices in regulations. The norms set out in Finanstilsynet’s mortgage lending guidelines are laid down as requirements in the draft regulations. This constraint on the banks’ exercise of discretion is the proposal’s most important contribution to tighter lending practices. Moreover, some tightening of the requirements is proposed compared with the existing guidelines.
Life insurance companies and pension funds
Life insurance companies and pension funds alike face major challenges in the coming years. Low interest rates are making it difficult to ensure sufficient return on pension assets. Although the share of defined contribution pension schemes is rising, about 80 per cent of life insurers’ insurance liabilities still comprise contracts with an annual guaranteed return. Further, pension institutions are having to make extra provision for future liabilities as a result of rising longevity.
The new prudential framework, Solvency II, is to be introduced across the EU on 1 January 2016. Solvency II reflects insurers’ real risk to a greater degree than does the current solvency regime. Among other things, insurance liabilities are to be measured at market value which, given the current low interest rate level, entails a substantial increase in the value of the liabilities compared with present rules. The new framework brings substantially higher capital requirements, in particular for life insurers offering a guaranteed return. The transition to the new framework is eased somewhat by a proposed transitional arrangement allowing the increase in the value of insurance liabilities to be phased in gradually over a period 16 years. Even so, a number of insurers will need to increase their capital in order to satisfy the new requirements.