Advice on the countercyclical capital buffer, 2014 Q3

Norges Bank’s letter of 17 September 2014 to the Ministry of Finance.

Norges Bank is responsible for preparing a decision basis and advising the Ministry of Finance on the level of the countercyclical capital buffer four times a year. On 27 June 2014, the Ministry of Finance decided to keep the buffer rate unchanged at 1 percent effective from 30 June 2015, in line with Norges Bank's advice. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2014 Q3 is presented in the September 2014 Monetary Policy Report.

The premise for Norges Bank's assessment is that banks should build up and hold a countercyclical capital buffer when financial imbalances are building up or have built up over a period. The buffer rate will be assessed in the light of other requirements applying to banks. The buffer rate can be reduced in the event of an economic downturn and large bank losses, with a view to mitigating the procyclical effects of tighter bank lending. The buffer rate should not be reduced automatically even if there are signs that financial imbalances are receding. The countercyclical capital buffer is not an instrument for fine-tuning the economy.

At the end of 2013, the Common Equity Tier 1 (CET1) ratios of the largest banks were 1–2 percentage points above the overall requirement as from 1 July 2014. Banks also posted solid earnings in the first half of the year.

Norges Bank's assessment of systemic risk is based on the credit-to-GDP ratio and its deviation from a long-term trend. Overall credit to households and enterprises is at a high level relative to mainland GDP. Credit growth has decreased somewhat since the financial crisis, and the credit indicator has remained fairly stable. Household debt is still growing somewhat more rapidly than disposable income, and there are signs that banks are easing credit standards for the household sector.

The European Systemic Risk Board (ESRB) recommends the calculation of technical reference rates for the buffer. The Basel Committee has proposed a simple rule for calculating a reference rate for the buffer on the basis of the credit-to-GDP ratio. The long-term trend in the credit indicator can be calculated by applying different methods. Applying the trend calculation method proposed by the Basel Committee, the reference rate is 0 percent. With an alternative trend calculation method, which has been shown to provide a better leading indicator of crises, the reference rate is ¾ percent. The ESRB emphasises that there should not be a mechanical relationship between the reference rate and the buffer rate, but that the rate should be based on a broader decision basis.

In addition to the credit indicator, Norges Bank takes account of developments in property prices and the share of bank funding obtained in financial markets. After falling in autumn 2013, house prices have in recent months risen in pace with household income. The commercial property price indicator is high and has risen over the past six months. Banks' share of market funding has been stable at a high level in recent years.

In Norges Bank's assessment, systemic risk has remained broadly unchanged since June. The decision basis indicates that the buffer rate should be kept unchanged at this time. Should house prices rise markedly faster than household income, systemic risk may increase further ahead. In the event of higher credit growth prospects, it will be appropriate to advise the Ministry to raise the level of the countercyclical capital buffer.

In preparing its advice, Norges Bank has exchanged information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway).



Øystein Olsen

Amund Holmsen

Published 26 September 2014 08:02