Submission

Countercyclical capital buffer 2016 Q1

Norges Bank's letter of 16 March 2016 to the Ministry of Finance

Norges Bank is responsible for preparing a decision basis and advising the Ministry of Finance on the level of banks' countercyclical capital buffer four times a year. The buffer rate is set at 1 percent. In June 2015, the Ministry of Finance decided to increase the buffer rate to 1.5 percent, effective from 30 June 2016. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2016 Q1 is presented in the March 2016 Monetary Policy Report (1/16).

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. 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.

Norges Bank's assessment of financial imbalances is based on the credit-to-GDP ratio and its deviation from a long-term trend. Overall credit to households and enterprises has expanded faster than mainland GDP for a long period. Towards the end of 2015, household debt growth moderated. Corporate debt growth remained moderate. The credit indicator nonetheless rose in Q4, partly reflecting lower growth in the Norwegian economy. According to Norges Bank's lending survey, banks have tightened credit standards for both households and enterprises. Funding costs have risen for many enterprises.

The European Systemic Risk Board (ESRB) recommends the calculation of a technical reference rate for the buffer. 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 was 0 percent in 2015 Q4. Using an alternative trend calculation method, which has been shown to provide a better leading indicator of crises, the reference rate was 1 percent in Q4, down from 1¼ percent in Q3. The ESRB emphasises that there should not be a mechanical relationship between the reference rate and the buffer rate, but that the requirement should be based on a broader decision basis.

In addition to the credit indicator, Norges Bank takes account of developments in real estate prices and banks' wholesale funding ratios. House price inflation has slowed over the past half-year, but there are substantial regional differences. House prices have risen marginally or fallen in oil regions, while house price inflation has been high in Oslo and many parts of southeast Norway. Housing market turnover has fallen slightly compared with a year ago. The commercial property price indicator continued to rise markedly in the second half of 2015. The required rate of return for high-standard office premises in central Oslo has fallen further, while rental prices have remained unchanged. Office rental prices have fallen in several other cities. Banks' wholesale funding ratios have been fairly stable.

Banks' profitability was solid in 2015 and their capital ratios strengthened. At the end of Q4, the largest banks' CET1 capital ratios averaged 14.4 percent. Banks are well positioned to meet their announced capital targets in 2016. Loan losses are still low.

Financial markets saw a turbulent start to the year. European bank share prices fell and credit risk premiums on bank bonds rose. Financial market turbulence has eased recently and credit risk premiums have fallen back. Norwegian banks continue to have ample access to wholesale funding and credit risk premiums have remained broadly unchanged since December.

The persistent increase in household debt ratios and high property price inflation in recent years are signs that financial imbalances have built up. On the whole, recent developments suggest that the imbalances are not building up further. Looking ahead, weak growth in the Norwegian economy may curb growth in both household and corporate debt. On the other hand, lower interest rates entail a risk of a pickup in property price inflation and debt growth.

On the basis of an overall assessment, Norges Bank's Executive Board has decided to advise the Ministry of Finance to keep the buffer rate unchanged at 1.5 percent.

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

Sincerely,

Øystein Olsen

Sindre Weme

 

Copy: Finanstilsynet

 

Published 17 March 2016 10:06