High household debt and high property prices are vulnerabilities posing a significant risk to financial stability in Norway. Many households have a very high debt burden and limited financial buffers. If the level of interest remains low, there is a risk that vulnerabilities will build up in households and firms in the coming years. Political unrest, trade conflicts and Brexit contribute to great uncertainty about developments in the international economy and financial markets. An international setback or new financial turmoil will affect the Norwegian economy and Norwegian financial markets.
Increasing household debt
The debt burden, measured by the ratio of debt to disposable income, has reached a historically high level and is higher than in the majority of other countries. The growth in household debt has gradually abated and is now roughly in line with the increase in households’ disposable income.
“Many households have a very high debt burden and limited financial buffers. High debt levels mean that even a moderate rise in interest rates will lead to a significantly higher interest burden. As most of the debt carries a floating interest rate, there will be a rapid increase in the interest burden,” says Director General Morten Baltzersen.
The growth in households’ consumer loans has slowed markedly through 2019. At end-September 2019, the twelve-month growth in consumer loans, including defaulted loans sold to finance companies for recovery, was on a level with the increase in total household debt. Regulation of banks’ consumer lending practices and establishment of debt information undertakings helps to mitigate risk in this market.
“Both the level of default and losses on consumer loans are increasing. There is a great risk that 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 loan losses and loss of reputation for the banks,” says Baltzersen.
Price growth in the Norwegian housing market has been moderate since the summer of 2018, but house prices are still at a very high level. Regional differences in price trends have declined. Commercial property prices have also risen steeply for several years, especially in the Oslo region. Prolonged strong price growth has contributed to heightening the potential fall in the property markets. Rising collateral values provide scope for increased borrowing, which in turn will push up prices.
Sound profitability in banks
Due to profitable operations, Norwegian banks have been able to meet higher capital requirements largely through retained profits. The banks’ Tier 1 capital as a share of total assets has increased over the past ten years, and the banks meet the liquidity requirements. The share of long-term market funding has risen. Norwegian banks are thus better positioned to provide credit in the event of an economic setback and increased loan losses. Norwegian banks’ common equity Tier 1 capital ratios and leverage ratios are slightly above the average for European banks.
Net interest income constitutes the predominant part of Norwegian banks’ operating income. Figures from the European Banking Authority (EBA) for the largest banks in each country show that Norwegian banks’ net interest income as a share of total income is higher than in many other European countries, where negative interest rates have put pressure on the interest margin.
A number of Norwegian banks, especially the largest ones, obtain a significant share of their funding in the Norwegian and international money and capital markets. The banks are thus vulnerable to market turbulence. There has been an appreciable increase in banks’ residential mortgage lending in recent years, also as a share of total lending. This increase is largely financed through the issue of covered bonds. 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 Ministry of Finance will adopt regulatory changes that implement the EU’s capital requirements directive (CRD IV) and regulation (CRR) in Norwegian law with effect from 31 December 2019. Seen in isolation, the measured capital adequacy ratio will consequently increase, although the banks’ financial soundness will remain unchanged. In Finanstilsynet's opinion, it is important to ensure that the implementation does not contribute to a general weakening of Norwegian banks' financial strength. When approving and following up internal models, Finanstilsynet will attach importance to robust calibration with satisfactory safety margins, and will, when setting Pillar 2 requirements, emphasise that these requirements should also capture risk that is not fully covered by the Pillar 1 requirement.
The capital adequacy of life insurers has been strengthened in recent years, and they are compliant with the Solvency II requirements. A protracted low interest rate level poses a challenge to institutions' ability to achieve the guaranteed return on their investments. Higher risk premiums in financial markets and declining equity prices are of particular consequence to insurers with a large proportion of paid-up policies in their portfolios.
Even though the proportion of defined-contribution pension schemes is increasingly strongly, contracts with an annual guaranteed return still represent the greater part of pension institutions’ obligations.
"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 scheme," says Baltzersen.
New solvency requirements for pension funds entered into force on 1 January 2019. Pension funds meet the new solvency requirements, although there are wide variations in their financial soundness.
Both physical climate change and the transition to a low emission society will have an impact on financial markets and financial institutions. The integration of climate risk in supervisory activity is high on the agenda of financial supervisory authorities in a number of countries, and work is in progress to develop supervisory tools to monitor firms’ handling of climate risk. Good reporting of relevant information from the firms is of significance to financial institutions’ risk assessments and the supervisory authorities' assessment of the financial soundness of individual firms and in the financial system as a whole. The Ministry of Finance has announced that the need for Norwegian regulatory changes will be assessed in light of how the recommendations of the Task Force on Climate-related Financial Disclosures are followed up in the market and new EU regulations to follow up the action plan on sustainable finance.