Reduced activity levels in oil-related industries after the oil price fall in 2014 have affected other parts of the Norwegian economy, although the contagion effects are thus far limited. There are now signs that activity levels in the mainland (non-oil) economy are picking up. House prices and household debt have risen steeply for many years. House prices and the household debt burden are at unprecedented levels, and household debt is rising significantly faster than household incomes. The vulnerability of the financial system has increased.
A turnaround in the form of an interest rate hike or increase in unemployment will most likely bring lower private consumption and falling house prices. The younger age groups in particular, with small financial buffers and high housing debt, are vulnerable. The record high indebtedness in the household sector will compound the negative effect of an interest rate hike and income lapse.
"The growth in house prices has slowed in recent months, but from a very high level. Stronger growth in the Norwegian economy and continued low interest rates could encourage further growth in house prices, but will at the same time increase systemic risk", says Mr Baltzersen.
The Ministry of Finance tightened the residential mortgage lending regulations somewhat as from 1 January 2017. This brought a slight tightening of lending practices and may in isolation have dampened pressures in the housing market, yet growth in household debt has remained high in recent months.
Banks' are heavily exposed to commercial property, a segment accounting for about 40 per cent of overall lending to the corporate market. Prices in parts of the commercial property markets have risen sharply.
"In the event of a setback in the housing markets and financial consolidation in the household sector, the contagion effects to commercial property could be substantial and inflict heavy losses on the banks, as witnessed in Norway and elsewhere during earlier crises", says Mr Baltzersen.
Households' borrowing in the form of unsecured loans carrying high interest has risen considerably in recent years. Consumer loans now make up a mere 3 per cent of household debt but accounted for close to 8 per cent of the overall increase in household debt in the twelve months to the end of this year's first quarter.
"The strong increase in consumer lending gives rise to concern. For many households consumer borrowing comes in addition to other debt, and can impose a heavy burden on individuals and households", says Mr Baltzersen.
Higher consumer debt will compound the effects of households' financial consolidation in the event of an economic setback. Finanstilsynet has expanded its supervision of consumer lending, and has raised capital charges for current and new providers of consumer loans. Finanstilsynet has now issued guidelines designed to encourage sounder lending practices in the provision of consumer loans.
Banks' financial position
Profit levels among Norwegian banks are good and considerably higher than the average of European banks. Banks' earnings fell somewhat in 2016 owing to higher losses on loans to the offshore industry, the large banks being those primarily affected. A considerable proportion of the banks' offshore clients has been or will be subject to restructuring. It is uncertain how large the losses will ultimately prove to be, and Finanstilsynet is keeping track of the banks' impairment provisioning through on-site inspections and analyses.
Despite strengthened risk-weighted capital ratios, the banks' equity ratio is not significantly higher now than in the mid-1990s. Financial institutions are required to meet the leverage ratio requirement as from 30 June 2017. This capital target ratio is not affected by changes in banks' risk models and risk-weighted assets. Norwegian banks had a leverage ratio of 7.3 per cent at the end of the first quarter this year, which is significantly higher than the anticipated minimum requirement in the EU.
Finanstilsynet conducts stress tests of Norwegian banks' results and capital ratios. The stress tests support assessments of financial stability, and are a tool supporting discretionary assessments of individual banks' future capital needs. As in previous years, the stress scenario in 2017 involves a serious shock to the Norwegian economy and Norwegian banks. The likelihood of this scenario taking place is low, but it is not unrealistic. The calculations illustrate that a number of banks are vulnerable in the event of a protracted shock. For some of them capital adequacy falls below the regulatory requirements. The results of the stress tests underline how important it is for banks to make allowance in their capital planning for an unfavourable outturn in the Norwegian and international economies.
Norwegian banks obtain a large share of their funding in the wholesale market, much of it raised abroad. Norwegian banks are thus dependent on confidence in the international money and capital market and on an absence of general turbulence in these markets.
A large proportion of the banks' market funding is in the form of covered bonds (OMF). This source of funding has benefited Norwegian banks and has contributed to longer funding maturities, but ties Norwegian banks' funding risk to a greater degree than previously to developments in the housing market. Sharp growth in house prices over a long period has heightened the potential fall. Covered bonds also account for a large proportion of Norwegian banks' liquidity reserve. These factors contribute to intensifying the interconnectedness between banks' credit, liquidity and funding risk.
Life insurers' financial position
The introduction of a fair-value-based solvency regime has been demanding for life insurers in a period of historically low interest rates and a substantial proportion of commitments carrying guaranteed interest. Transitional arrangements have been made available to ease the switch to a new body of rules.
"Life insurers have cut costs and adapted their insurance funds investments and by and large meet the increased provisioning requirements resulting from rising longevity. The institutions meet the new solvency requirements by a fairly ample margin", says Mr Baltzersen.
In addition to fulfilling the regulatory requirements at all times, institutions must also assess their own capital needs and the capital targets with which to meet future capital needs. Finanstilsynet has made it clear to some institutions that their capital targets appear to be low. This has prompted some institutions to raise their internal targets with a view to achieving a satisfactory solvency coverage ratio.
Silver Pensjonsforsikring AS was placed, as the first Norwegian life insurer, into public administration in February 2017. This was necessary in order to assure equal treatment of policyholders' insurance claims and to protect policyholders' best interests. Silver's portfolio accounts for a relatively small portion of the overall paid-up policy portfolio in Norway. The substantial undercoverage at Silver is detrimental to the company's policyholders. The insolvency has however not led to general unease in the Norwegian insurance market.