Financial trends 2016

Households

Household debt has grown faster than household incomes for a long time. The debt burden is at an unprecedented high level and is high compared with other countries. House prices have also grown faster than household incomes, and in the past year the difference in growth rate has widened. Credit growth and house price growth are mutually reinforcing. Higher house prices increase household wealth and raise mortgage values, providing an opportunity for further borrowing. Expectations of continued low interest rates could contribute to maintaining high growth in house prices and debt in the years immediately ahead, thereby adding to the debt burden.

"Interest rates are at unprecedentedly low, giving households a moderate interest burden. However, the interest burden will rise markedly should interest rates go up. The effect of higher interest rates is particularly marked when indebtedness is high. The longer the debt build-up lasts and the more house prices rise, the larger the potential fall in the Norwegian economy", says Finanstilsynet's Director General, Morten Baltzersen.

A sharp interest rate hike and a turnaround in household expectations could have major negative ripple effects in the economy. The immediate impact of higher interest rates is an increased debt burden which may be followed by reduced house prices. Financial consolidation in the household sector could in the next instance lead to reduced consumption, lower corporate investments, increased unemployment and reduced real disposable income. A sharp fall in house prices and securities will for large groups of households cause the value of their assets to fall below the value of their debt. This applies in particular to younger borrowers who have small financial buffers and high residential mortgage debt.

Banks

"Stable net interest revenues and low loan losses have provided Norwegian banks with good profits for many years. Overall book losses on loans remain low, but losses on loans to oil and offshore segments have risen. It is above all the larger banks that are directly exposed to the oil sector and hence account for the increase in loan losses. Finanstilsynet has made it clear to the banks that their provisioning for losses on risky exposures must be sufficient and must be based on prudent valuations," says Mr Baltzersen.

Negative impacts of shocks that are inflicted on the Norwegian economy can be dampened by good risk management and prudent credit practices on the part of the banks. Finanstilsynet's annual residential mortgage loan survey shows that banks have granted somewhat fewer loans with a high loan-to-value ratio than in 2015. The banks have however granted a larger proportion of repayment loans where the borrower's income was insufficient to meet normal living expenses or to pay instalments and interest expenses after an interest rate increase of five percentage points. The survey also shows that total debt relative to gross income rose compared with previous years, and rose by the largest margin in the case of young borrowers. Finanstilsynet has recommended to the Ministry of Finance that the current residential mortgage lending regulations should be retained and tightened.

"Household debt consists mainly of loans secured on dwellings. Of late strong growth has also been seen in households' consumer loans. This type of debt accounts for a small portion of households' aggregate debt, but is marketed very actively by banks and finance companies. It is important that institutions that offer this product have sound procedures for assessing customers' creditworthiness, and that their advisory services give due emphasis to the individual customer's long-term interest", says Mr Baltzersen.

This spring Finanstilsynet adopted new guidelines for banks' invoicing of credit cards which inter alia require that the customer's invoice shows the overall outstanding credit and that the credit limit should not be raised without the customer applying for this. Many companies have failed to comply with the guidelines. Finanstilsynet has accordingly recommended the Ministry of Finance to adopt regulations based on the requirements of the guidelines.

Alongside prudent credit practices, there is a need for solid banks that are well prepared to withstand unforeseen losses. Finanstilsynet also expects the banks to take steps to ensure that aggregate common equity tier 1 capital adequacy exceeds the sum of Pillar 1 and 2 requirements by an ample margin. The banks should attach importance to the need for the space for action required to maintain normal lending activity in downturns and to ensure that their capitalisation supports access to the capital markets under difficult conditions as under good conditions. Norwegian banks are vulnerable to turbulence in international financial markets. That is why it is also important for banks to hold sufficient long-term stable funding along with good liquidity buffers.

"In Finanstilsynet's assessment the banks should, in light of the uncertainty regarding economic developments, safeguard their financial position by retaining a significant portion of this year's net profit", says Mr Baltzersen.

Life insurers and pension funds

The low level of long-term interest rates has intensified pressures on life insurers internationally. Expectations of possible protracted low interest rates for a long period ahead have weakened profit prospects, in particular for insurers with a large portion of guaranteed pension products. The low interest rate also poses a major challenge for Norwegian pension institutions, a significant portion of whose liabilities carry a guaranteed annual return.

"Pension institutions' asset management must be aligned in a manner that safeguards policyholders' guaranteed benefits. It is also in the policyholders' interest to achieve a return on their assets above the guaranteed interest. However, an increase in expected return that can be achieved through increased risk in asset management requires pension institutions to maintain a risk-bearing capacity in the form of solvency capital", says Mr Baltzersen.

Solvency II has not being given effect for pension funds, which remain subject to the capital requirement under Solvency I. Pension funds have however since 2012 reported stress tests based on the valuation principles of Solvency II. Finanstilsynet has recommended that a simplified version of the Solvency II capital requirement based on the stress tests should be introduced as a binding capital requirement for pension funds. This will play a part in bringing pension funds under capital requirements that in the main correspond to those applying to life insurers, so that members of pension funds are afforded the same security for future disbursements as persons with a pension plan provided by a life insurer.

The Solvency II regime reflects life insurers' risk related to low interest rates and a high proportion of products providing a guaranteed return. Insurers should in the main retain profit in order to strengthen their financial position, even if the opportunity to utilise transitional rules mitigates the challenges in the short-term.