Growth rates in the global economy and the Norwegian economy remain buoyant. After
a prolonged period of very low interest rates, there is however a risk that financial imbalances have built up. High asset prices and a high debt burden render the economic system vulnerable in the event of a stronger-than-expected interest rate hike and increased risk premiums in the financial markets.
House prices have risen steeply for a number of years. Regardless of how growth in house prices is measured, house price growth in Norway is high compared with other Nordic countries and the OECD area.
"The temperature of the housing market declined in 2017. The price fall was strongest in Oslo, where the rise in prices in 2016 had been most marked. Price growth has picked up again in the current year. The further path of the housing market is uncertain. Continued strong price growth will spur growth in household debt and heighten the potential fall in the Norwegian economy and the risk of financial instability," Finanstilsynet's Director General, Morten Baltzersen said.
Norwegian banks and insurers are heavily exposed to commercial property companies. Although banks have implemented risk-mitigating measures, including requirements on pre-leases and on equity capital when financing development projects, a steep price fall would impair commercial property company earnings and reduce the value of banks' collateral.
Norwegian households' debt burden is high on average and, for a large proportion of households, very high. Inasmuch as almost all household debt carries floating interest, households are highly vulnerable to interest rate hikes.
"A strong interest rate hike could trigger a considerable and abrupt fall in household purchases of goods and services which would likely hit the Norwegian economy on a broad front and lead to impaired earnings and financial positions of Norwegian firms and financial institutions," Mr Baltzersen said.
Finanstilsynet recommended in February continuing the residential mortgage lending regulations, subject to some adjustments. Subsequent developments support the rationale for continuing the regulations as proposed by Finanstilsynet.
The growth in consumer lending by financial institutions has slowed somewhat, but remains very high. Such loans are actively marketed by banks and finance companies. There is a risk of financially vulnerable households taking out consumer loans at high interest that they are subsequently unable to service. This could result in a heavy personal burden for the individual borrower, and in loan losses and loss of reputation for banks.
A number of steps have been taken in the past year to regulate consumer lending. In June 2017 Finanstilsynet adopted guidelines on consumer lending practices. A survey of institutions' implementation of the guidelines as of the fourth quarter of 2017 shows that many banks have yet to bring their lending activity into line with the guidelines.
"This is not satisfactory, and Finanstilsynet will monitor banks' compliance with the guidelines in the period ahead. Finanstilsynet has stepped up its supervisory activity vis-à-vis banks specialising in consumer lending and has tightened the capital charges set for the banks concerned," Mr Baltzersen said.
The Norwegian banking industry has recorded good performances in the years following the international financial crisis, thereby improving their capital adequacy ratios. Norwegian banks are therefore well equipped to provide credit in the event of a downturn and increased losses.
Full implementation of the EU directive and regulation on capital requirements (CRR / CRD IV) in Norwegian law will in isolation permit Norwegian banks to report higher capital adequacy ratios without this reflecting improved solvency.
"It is important to ensure that adapting Norwegian capital adequacy rules to EU rules does not contribute to a general weakening of Norwegian banks' solvency in real terms," Mr Baltzersen said.
The banks have enjoyed ample access to funding in recent years, including funding from foreign sources. They meet the liquidity buffer requirements and have also raised their share of long-term funding.
"The banks continue to fund a substantial portion of their business in the money and capital markets both in Norway and abroad. This renders them vulnerable to increased global uncertainty," Mr Baltzersen said.
Finanstilsynet's stress test for 2018 shows that many banks experience a considerable reduction in CET1 capital adequacy in the event of a severe negative shock in the Norwegian economy. In the stress scenario world trade declines dramatically, oil prices fall and risk premiums rise concurrent with falling equity and property prices. The likelihood of this scenario materialising is low, but not unrealistic. Several banks are not compliant with the regulatory capital requirements at the end of the stressed period.
In the period since Solvency II entered into force in 2016, life insurers' solvency has strengthened, and life insurers meet the Solvency II requirements by a good margin. Despite a slight increase in interest rates at the start of 2018, rates remain low. Pension institutions with a large proportion of paid-up policies are particularly vulnerable to low interest rates inasmuch as an increase in the value of liabilities cannot be compensated for by raising interest guarantee premiums since no premiums are payable on paid-up policies. The proportion of overall commitments linked to paid-up policies has risen markedly in recent years both at life insurers and at private pension funds. Life insurers are subject to Solvency II, entailing a substantial capital charge for the return risk associated with paid-up policies. Finanstilsynet has recommended that pension funds should also be subject to more risk-sensitive capital requirements corresponding to Solvency II to provide added assurance of future pension payments.