Submission

Advice on the countercyclical capital buffer 2016 Q4

Norges Bank's letter of  14 December 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 1.5 percent effective from 30 June 2016. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2016 Q4 is presented in the December 2016 Monetary Policy Report (4/16).

Banking regulation and macroprudential policy measures are the first line of defence against financial instability. The premise for Norges Bank's assessment of the countercyclical capital buffer is that banks should build up and hold a 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 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. Capital levels continued to rise in 2016 Q3. The largest banks are well positioned to meet their capital targets, which are above regulatory capital requirements. Banks' loan losses have increased over the past year, particularly on oil-related exposures. Banks' loan losses will probably increase somewhat in the quarters ahead, but are nonetheless expected to remain at relatively low levels.

Norges Bank's assessment of financial imbalances is based on the ratio of total credit to GDP for the mainland economy and its deviation from a long-term trend. Total credit has risen faster than GDP over a long period. Recently, credit growth has slowed somewhat, and credit is now growing at a slower pace than GDP. The European Systemic Risk Board (ESRB) recommends the calculation of technical reference rates for the countercyclical capital buffer (a buffer guide). The reference rates reflect the level of the credit-to-GDP ratio measured as the deviation from its estimated long-term trend. The reference rate was ¼ percent in 2016 Q3 when the trend is estimated using Norges Bank's method, and 0 percent when applying the trend estimation method proposed by the Basel Committee. 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.

To assess financial imbalances, it is necessary to analyse the various credit components. Lower growth in total credit primarily reflects a decline in corporate foreign debt, attributable in part to the stronger krone. Growth in corporate debt from domestic sources has been moderate over the past year. There are no signs that creditworthy enterprises have problems with access to credit.

Growth in household debt has been main force behind the higher rate of growth in total credit relative to GDP growth over time. Recently, household debt growth has accelerated and debt-to-income ratios have continued to rise. Very highly indebted households are particularly vulnerable to a rise in interest rates and a loss of income. Over the past year, the share of new loans with debt over five times gross income has increased considerably.

In addition to the credit indicator, Norges Bank takes account of developments in property prices and banks' wholesale funding ratios. Banks' wholesale funding ratios have been fairly stable over time, and Norwegian banks have ample access to wholesale funding.

House prices have risen at a considerably faster pace than household disposable income over the past year. In recent months, house prices have risen sharply in many parts of the country. Close to half of Norway's population lives in regions where house prices have risen by 10 percent or more over the past year. In oil-dependent regions, house price inflation is still low. Commercial property prices in central Oslo have risen sharply over a number of years.

Growth in the Norwegian economy is subdued, but house prices are rising sharply. Household debt accumulation is high partly owing to the rapid rise in house prices. This increases the vulnerability of many households and heightens the risk of a sharp fall in demand and an increase in loan losses for banks further out. High house price inflation and a continued rise in household debt ratios are signs that financial imbalances are building up further. This suggests a higher countercyclical capital buffer rate. Banks' loan losses have recently edged up, but banks profit margins remain solid. Banks are well positioned to meet higher capital requirements, which will better equip banks to cope with increased losses further ahead.

On the basis of an overall assessment, Norges Bank's Executive Board has decided to advise the Ministry of Finance to increase the buffer rate from 1.5 to 2 percent effective from 31 December 2017.

Norges Bank is responsible for advising the Ministry of Finance on countercyclical capital buffer rates for Norwegian banks' exposures in non-EU countries. For exposures in EU countries, the buffer rate in the individual country must be applied. In principle, countercyclical buffer rates in non-EU countries must also be applied. For exposures in countries that have not set their own rate, the Norwegian buffer rate applies. The Ministry of Finance may set different rates for exposures in non-EU countries. Norges Bank will in principle follow the ESRB's recommendations on buffer rates for non-EU countries when they are published and for the time being there is no basis for recommending different rates.

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 15 December 2016 10:00