There is a strong trend in the Norwegian economy. However, high property prices and high and rising household debt levels increase the vulnerability of the Norwegian economy. A strong rise in interest rates, new international financial turmoil or other economic shocks could trigger a sharp fall in property prices and an abrupt slowdown in household demand for goods and services. Profitable and well-capitalised banks are important for the capacity of the Norwegian economy and the financial system to withstand economic and financial shocks.
“The continued rise in households’ debt burden gives cause for concern. In order to ensure that the Norwegian economy is well prepared to face potential economic shocks, it is important that the capital adequacy levels built up by the banks after the financial crisis are not impaired,” says Finanstilsynet’s director general, Morten Baltzersen.
High property prices and a high household debt burden represent a particular vulnerability of the Norwegian economy. Norwegian household debt is still growing faster than household income and now represents approximately 230 per cent of the sector’s disposable income. This is a high debt burden both in historical terms and compared with other countries, and there is a danger that the debt burden will increase further in the coming years. As a consequence of a rising debt burden in the household sector, financial imbalances are building up in the Norwegian economy.
“Many households are vulnerable to rising interest rates and declining incomes. Given the high level of debt with floating interest rates, an interest rate hike will rapidly impair household finances. This could intensify a possible setback in the Norwegian economy and cause higher losses for the banks, especially on corporate loans,” says Mr Baltzersen.
Consumer loans are actively marketed by banks and finance companies. The increase in consumer lending has slowed somewhat, but remains high.
“There is a risk that financially vulnerable households will take out consumer loans at high interest rates that they are subsequently unable to service. This could result in a heavy personal burden for the individual borrower, and in both loan losses and loss of reputation for banks,” says Mr Baltzersen.
In June 2017, Finanstilsynet issued guidelines for prudent consumer lending practices and in August 2018 sent draft regulations on lending practices to the Ministry of Finance. The Ministry of Finance has circulated the matter for comment. The deadline for response is 6 December 2018.
Residential mortgage lending survey
The Ministry of Finance issued new residential mortgage lending regulations in June 2018, which were a continuation of the previous regulations with a few minor changes. The regulations will remain in force until 31 December 2019.
When compared with the previous year's survey, the survey of new residential mortgages conducted this autumn shows a slight increase in the proportion of borrowers whose total debt exceeds five times gross annual income. The same applies to loans with a loan-to-value ratio (the ratio of mortgage to property value) above 85 per cent and loans raised by borrowers whose debt servicing capacity will be inadequate if interest rates increase by 5 percentage points. On the other hand, borrowers' average debt-to income ratio (the ratio of total debt to gross annual income) has increased significantly by 19 percentage points compared with last year's survey. The average debt-to income ratio for borrowers taking out new residential mortgages has now reached 334 per cent for instalment loans and 287 per cent for home equity credit lines.
“The residential mortgage lending survey indicates that the residential mortgage lending regulations have helped to limit the proportion of new mortgages taken out by households with a very high debt-to-income ratio or a very high loan-to-value ratio. Borrowers’ average debt-to-income ratio has nevertheless increased significantly. The debt-to-income and loan-to-value ratios are particularly high among younger borrowers,” says director general Morten Baltzersen.
There has been a moderate rise in house prices in recent months, but the price level is high.
“The onward path of the housing market is uncertain. The sound trend in the Norwegian economy is expected to continue and will help to maintain the demand for residential property. At the same time, higher interest rates, a large number of new homes in the market and slower population growth may put a damper on house prices," says Morten Baltzersen.
The prices of high-quality commercial properties at prime locations, especially in the Oslo region, have risen significantly over several years. A substantial share of property companies’ financing is provided by banks. Higher interest rates will contribute to weakening the earnings of property companies and reduce the value of creditors’ collateral. High commercial property prices represent a vulnerability of the financial system.
Norwegian banks enjoy strong profits, partly du to low loan losses. This has enabled the banks to meet stricter capital requirements largely through retained profits. Lower risk weights have also contributed to an increase in measured capital adequacy. Norwegian banks have also raised their leverage ratios after the financial crisis. The banks meet the liquidity buffer requirements and have increased their long-term market funding. Norwegian banks are therefore better positioned to provide credit in the event of an economic setback and increased losses.
A number of Norwegian banks, especially the largest ones, obtain their funding in the Norwegian and international money and capital markets. This makes the banks vulnerable to market turbulence. There has been a significant increase in banks’ residential mortgage lending in recent years, both in absolute terms and relative to total lending. This increase is largely financed through the issue of covered bonds (OMF). In addition, banks have invested heavily in covered bonds issued by other banks. Developments in house prices thus have a strong bearing on the banks' credit and liquidity risk.
The capital adequacy of insurers has been strengthened, and they are compliant with the new solvency requirements (Solvency II) that came into effect in 2016. The low interest rate level has posed a challenge to institutions' ability to achieve the guaranteed return on their investments. Adapting to the new requirements has proven particularly challenging for life insurers with a large proportion of guaranteed liabilities.
The transition from defined-benefit to defined-contribution pension schemes with no guaranteed rate of return entails that the return risk is transferred from employers or pension institutions to the individual member covered by the pension scheme. It is important that institutions give their customers detailed information about expected returns, risk and costs related to the defined-contribution schemes.