Risk Outlook – December 2022
Published: 8 December 2022
Document number: 12/2022
In Finanstilsynet's view, there is a heightened risk of financial instability in the period ahead. The war in Ukraine, the impact of the Covid-19 pandemic and high inflation give rise to considerable economic and financial uncertainty. High debt in Norwegian households and elevated residential and commercial property prices still represent the key vulnerabilities in the Norwegian financial system.
The crisis in the energy markets and supply chain disruptions, coupled with high demand for goods and services, have contributed to a sharp rise in global consumer price inflation. Central banks in several countries have raised their policy rates considerably and announced further rate hikes. In addition, central banks are tightening monetary policy by scaling back their bond holdings.
There is an increased risk of stagnant economic activity coupled with high consumer price inflation, so-called stagflation. In the event of stagflation, there will be few fiscal and monetary policy instruments available to counteract an economic downturn by stimulating demand for goods and services.
House prices in Norway have risen considerably over a long period of time and significantly more than disposable income per capita. In recent months, there has been a major shift in the housing market. Interest rate increases and economic uncertainty entail a heightened risk of a sharp fall in house prices.
Households’ debt burden is high both in historical terms and compared with other countries, and the share of households with a particularly heavy debt burden has increased in recent years. Only a small proportion of household debt carries fixed interest rates. Higher interest rates will therefore quickly be reflected in rising interest expenses.
“Many Norwegian households are particularly vulnerable to a sharp rise in interest rates, loss of income and declining house prices. Debt problems in the household sector will have major economic and financial repercussions,” says Finanstilsynet’s Director General, Morten Baltzersen.
Commercial property prices have risen markedly over the past decade as a result of increasing rental prices and low required rates of return. The banks have a significant loan exposure to commercial property companies. In the past, both Norwegian and international banks have suffered substantial losses on commercial property exposures during severe downturns.
“A strong rise in interest rates and higher risk premiums may lead to a substantial fall in commercial property prices and increased credit risk for the banks. Commercial property companies also have large volumes of debt falling due over the next few years, which entails a considerable refinancing risk,” says Baltzersen.
Norwegian banks meet the regulatory capital requirements. Their profitability is strong and has improved since 2020, partly due to low loan losses. Higher interest rates and weaker economic developments increase the risk that loan losses may rise in the period ahead.
The stress test of Norwegian banks presented by Finanstilsynet in June and the updated stress test that is now presented show that the banks may suffer substantial losses and be required to draw on their capital.
“It is vital that the banks are well capitalised to be able to absorb higher loan losses and provide loans to creditworthy customers even during bad times. Finanstilsynet expects Norwegian banks’ capital planning to factor in losses that may arise in a stagflation scenario featuring a sharp rise in interest rates, higher unemployment and a property market crash,” says Baltzersen.
The war in Ukraine and several attacks on infrastructure in Europe, as well as general geopolitical uncertainty, place greater demands on emergency preparedness, also in the financial sector. The risk of major cyber incidents with serious consequences has increased. Such incidents may have a strong impact on the financial infrastructure, especially if they affect critical functions in the financial system.