Advice on the countercyclical capital buffer 2014 Q4
Norges Bank's letter of 10 December 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 26 September 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 Q4 is presented in the December 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. 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.
Banks' profitability was solid in 2014 Q3. At the end of the quarter, the Common Equity Tier 1 (CET1) ratios of the largest banks were 2–3 percentage points above the total capital requirement applicable from 1 July 2014.
Norges Bank's assessment 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. There are signs that banks are easing credit standards for the household sector, and lending rates have been reduced. Corporate debt growth has slowed markedly over the past year.
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 ½ 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 picked up through 2014. In some months through summer and autumn, house price inflation has been especially strong, and over the past year house prices have risen faster than household disposable income. The commercial property price indicator is high and has risen over the past six months. Banks's share of market funding has been stable at a high level in recent years.
In Norges Bank's assessment, there has not been a further build-up of financial imbalances as a whole. Recent developments in the housing market and banks' lending standards may increase household vulnerability. On the other hand, corporate credit growth is low, and the fall in oil prices has increased the risk of substantially weaker developments in the Norwegian economy. The decision basis suggests that the buffer rate should be kept unchanged now. Should house prices continue to rise markedly faster than household income in the period ahead, with a further build-up in financial imbalances, 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).