The oil price fall is making its mark on the Norwegian economy. Activity levels in the oil sector have fallen sharply, and there is substantial overcapacity in oil-related industries. Large parts of the offshore fleet are laid up, and many companies are making workforce reductions. However, ripple effects to the wider Norwegian economy have thus far been limited. Expansionary fiscal policy, low interest rates and a weaker krone exchange rate are helping to maintain activity levels in other parts of the economy. The oil price fall has mainly affected regions with a large element of oil-related industries.
Banks have returned good profits in the years following the financial crisis. Non-performance and loan losses remain at a low level, and banks have not seen a need to increase their loss provisions to an appreciable degree. There is substantial overcapacity at many offshore companies, and it is highly uncertain whether laid-up vessels will ever resume activity. Banks' collateral values are substantially reduced, and history provides little basis for the valuation of current collaterals. There is a risk that historical loss and default figures understate true loss potentials.
The volume of loans from Norwegian banks to borrowers on repayment relief has risen of late. This was also seen during the banking crisis in Norway and after the international financial crisis. Forbearance has in general taken the form of reduced instalment payments or longer maturity periods. Even where borrowers are still able to pay interest on their debt, and the debt is therefore not classified as non-performing, banks must none the less evaluate the risk of loss on these loans and make the necessary loss provisions.
"It is important that banks provision sufficiently for loss on risky exposures, both on individual exposures and exposure groups", says Morten Baltzersen, Finanstilsynet's Director General.
Norwegian banks have increased their equity capital following the international financial crisis, mainly by means of profit retention. While the common equity tier 1 capital ratio has risen substantially in the period, the leverage ratio has risen by a smaller margin. The latter is still no higher than it was in the mid-1990s. This is because total assets have grown faster than risk weighted assets.
Finanstilsynet's stress test of Norwegian banks shows that bank losses could be more substantial in the event of a severe setback in the Norwegian economy. Norwegian banks are heavily exposed to residential and commercial property. A major need for consolidation in the household sector and a sharp fall in real estate markets will inflict substantial losses on banks, both direct losses on loans secured on property and indirect losses resulting from economic ripple effects to large parts of the Norwegian economy. A strengthened financial position has given banks a better basis on which to meet a setback in the economy, but banks need to further increase their equity capital in 2016.
Norwegian banks obtain a large share of their funding in the wholesale market. Much of it is denominated in foreign currency and has a maturity below three months. Risk premiums on banks' funding rose through 2015 and up to the start of 2016, but have fallen somewhat of late. Norwegian banks are vulnerable to turbulence in international money and capital markets. It is therefore imperative for banks to maintain sufficient liquid reserves and to fund their long-term assets on a long-term basis.
Households' debt burden and house prices are at historically high levels. Many households are heavily indebted relative to income and their financial buffers are small. Growth in household debt and house prices has continued to outstrip growth in incomes. However, there are wide regional differences in the housing market, with a fall in prices in Stavanger and very rapid price growth in Oslo. The growth in credit and house prices has helped to maintain activity levels in the Norwegian economy. Low borrowing costs and expectations of a protracted low interest rate are an important contributory factor. Despite a weaker trend and increased uncertainty in the Norwegian economy, there is a risk that the rapid growth in house prices and household debt could last for a period. Such an outturn would increase the risk of a subsequent sudden, sharp decline in house prices and economic setback.
Consumer loans represent a small share of households' overall debt, but this debt is growing strongly, and the market is characterised by very active marketing by banks and finance companies.
"Consumer loans carry high interest, and poor servicing capacity can impose heavy burdens on many individuals. Losses on such loans could rise substantially. Banks' reputation may also be impaired. Banks should acknowledge a particular responsibility for safeguarding their customers' long-term interests when offering such loans" comments Mr Baltzersen.
Life insurers and pension funds
Life insurers and pension funds face major challenges in coming years. Low interest rates make it difficult to achieve sufficient return on contracts offering an annual guaranteed rate of return. Rising longevity compels pension institutions to make extra provision for increased liabilities. Pension institutions have already provisioned for about 90 per cent of the overall requirement for increased longevity provisions. What remains of the need for increased provisioning refers primarily to the paid-up policy portfolio.
Under Solvency II insurance liabilities are accounted for at market value. The current low interest rate level entails significantly increased liabilities compared with the rules in force up to 31 December 2015. The new regime brings substantially higher capital charges which more adequately reflect the risk involved. Life insurers are allowed a period of 16 years in which to adapt to the new rules, implying a gradual escalation of technical provisions to the point where, by the end of the escalation period, they match the insurance liabilities' market value.
Solvency II does not apply to pension funds, which will be subject to the capital requirements under Solvency I until further notice. In Finanstilsynet's view the Solvency II requirements provide a better picture of pension funds' actual financial position than the current solvency framework. Finanstilsynet has therefore recommended that pension funds be subject to a capital requirement based on stress test I, which is a simplified version of the requirement under Solvency II.