Submission

Countercyclical capital buffer 2016 Q2

Norges Bank's letter of 22 June 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 the countercyclical capital buffer for banks four times a year. The buffer rate is set at 1 percent and will increase to 1.5 percent effective from 30 June 2016. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2016 Q2 is presented in the June 2016 Monetary Policy Report (2/16).

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. Advice to reduce the rate will be based on factors such as information about any market turbulence, significant credit supply tightening and prospects for substantial bank losses. The countercyclical capital buffer is not an instrument for fine-tuning the economy.

Norwegian banks have built equity capital in recent years in order to meet higher Common Equity Tier 1 (CET1) requirements, including the countercyclical capital buffer. Profitability in the banking sector is solid and capital levels continued to rise in Q1. The largest banks meet the requirements applicable from summer 2016 by an ample margin, but must continue to build capital to reach their announced capital targets by the end of the year. Banks' loan losses have edged up, but are still at low levels. Some banks have increased their loss projections somewhat.

Norges Bank's assessment of financial imbalances is based on the credit-to-GDP ratio and its deviation from a long-term trend. Total credit to households and enterprises has expanded faster than mainland GDP for a long period. Overall credit growth has edged down in recent quarters. The credit indicator has nonetheless risen due to lower growth in the Norwegian economy.

Household debt continues to rise faster than disposable income. Mainland corporate debt growth is moderate. Growth in corporate bank debt is holding steady, while growth in bond debt and foreign debt is low. The banks in Norges Bank's lending survey report unchanged credit standards for enterprises as a whole, but some tightening for commercial real estate and oil-related enterprises. Risk premiums have decreased for enterprises with a high credit rating, but have risen for oil service enterprises.

The European Systemic Risk Board (ESRB) recommends the calculation of technical reference rates for the buffer (a buffer guide). The reference rates will reflect the level of the credit indicator measured as its deviation from estimated trends. Applying the trend estimation method proposed by the Basel Committee, the reference rate was 0 percent in 2016 Q1. Using an alternative trend estimation method, which has been shown to provide a better leading indicator of crises, the reference rate was 1 percent in 2016 Q1, the same as in 2015 Q4. The ESRB emphasises that there should not be a mechanical relationship between the reference rate and the buffer rate, but that the buffer rate 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 prices have risen sharply in recent months. There are substantial regional differences. House prices are rising rapidly in Oslo and the surrounding areas, but have fallen in oil-dependent regions. The commercial property price indicator has shown a sharp rise over the past year. Banks' wholesale funding ratio is stable and Norwegian banks have ample access to wholesale funding. Risk premiums on bank bonds have fallen considerably in recent months.

The persistent rise in household debt burdens and high property price inflation in recent years are signs that financial imbalances have built up. Growth in overall credit has edged down recently, while house price inflation has accelerated. Our overall assessment of financial imbalances is little changed since March. Weak growth in the Norwegian economy may curb debt growth ahead in both the household and the corporate sector. On the other hand, low interest rates may contribute to sustaining the high level of property price inflation and drive up household debt growth, increasing the risk of an abrupt decline in demand and future bank loan losses.

Higher capital ratios have increased Norwegian banks' resilience. Bank loan losses are still at low levels. On the whole, it appears that the supply of credit from domestic sources to the corporate sector remains steady.

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.

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

Torbjørn Hægeland

Copy: Finanstilsynet

Published 23 June 2016 10:09