Why does financial instability build up?

Financial instability may originate in financial imbalances that build up over time or in contagion channels in financial networks.

• Risks that intensify over time may be due to the interplay between the financial system and the real economy. In good times, asset prices rise and credit risk may be perceived as low. Credit growth may then accelerate, amplifying the expansion. In bad times, risk willingness may decrease, with the perception of risk becoming more acute. As many will choose to reduce their indebtedness at the same time, asset prices fall.  
• Problems can spread between financial institutions because of cross exposures, reliance on funding from the same markets or exposure to the same risks. 

Banks are important

With their key role in providing credit and in facilitating payments, banks differ from other financial institutions in that they fund their operations from customer deposits. Considerable emphasis is therefore placed on the outlook for banks’ earnings and solvency and on assessing banks’ risk exposure.

Credit risk

An important risk factor for banks is credit risk, ie the risk that borrowers will fail to meet payment obligations. Analysis of developments in household and corporate finances and in asset prices is therefore an important part of the Bank’s oversight work.

Liquidity risk

Another important risk factor for banks is liquidity risk, ie the risk that a financial institution will not meet payment obligations when due without incurring substantial additional costs. Monitoring of bank liquidity is therefore important to prevention and management of liquidity crises.

In its monitoring of financial institutions and securities markets, Norges Bank uses a broad spectrum of data and analytical tools. Norges Bank has a particularly sound basis for oversight of parts of the payment system as the Bank has responsibility for licensing interbank payment systems, for executing interbank settlement between participants in Norges Bank’s settlement system (NBO) and has primary responsibility for the cash supply. 

Publication of our oversight work

Financial imbalances and the banking sector are assessed in Norges Bank's Monetary Policy Report in conjunction with Norges Bank's monetary policy assessments and the decision basis for the countercyclical capital buffer for banks.

The annual Financial Stability Report takes a closer look at the banks' situation and longer-term, structural features of importance for financial stability.

Each quarter the Bank conducts a survey of bank lending to assess changes in credit demand or supply as well as changes in banks’ loan terms and conditions. See Norges Bank’s Survey of Bank Lending.

Although Norges Bank’s oversight of the payment systems focuses primarily on limiting risk in the interbank systems, the Bank also follows important trends in the wider payment system. The results of the Bank's oversight work are presented in the Financial Infrastructure Report.

Oversight of licensed interbank payment systems is conducted by means of reporting requirements, supervisory meetings etc. Oversight is performed in accordance with international recommendations.