Advice on the countercyclical capital buffer, 2014 Q2
Norges Bank's letter of 18 June 2014 to the Ministry of Finance.
Norges Bank shall draw up a decision basis and advise the Ministry of Finance on the level of banks' countercyclical capital buffer four times a year. In the Regulation on the Level of the Countercyclical Capital Buffer of 12 December 2013, the buffer rate was set at 1 percent effective from 30 June 2015. On 4 April, the Ministry of Finance decided to leave the level unchanged in line with the advice submitted by Norges Bank.
The decision basis for the advice in 2014 Q2 is presented in the June 2014 Monetary Policy Report. As part of its work in preparing the advice, Norges Bank has exchanged information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway).
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 over a period. 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 countercyclical capital buffer is not an instrument for fine-tuning the economy.
According to the Regulation on the Countercyclical Capital Buffer, the decision basis shall "(...) contain an overview of the credit-to-GDP ratio and the extent to which it deviates from the long-term trend, as well as other indicators, and Norges Bank's assessment of systemic risk that is building up or has built up over time". In addition to the credit indicator, Norges Bank has to date placed emphasis on developments in property prices and banks' share of wholesale funding.
From the mid-1990s until 2008, total credit to households and mainland enterprises grew at a markedly faster pace than economic activity. Since the financial crisis, credit growth has slowed somewhat, and the credit indicator has remained fairly stable. Household debt ratios are high, and debt is still rising somewhat faster than disposable income.
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 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 in 2014 Q1. With an alternative trend calculation method, which has been shown to provide a better leading indicator of crises, the reference rate is ½ percent.
House price inflation has long outstripped the pace of growth in household disposable income. House prices fell in autumn 2013. In recent months, house prices have picked up again. The price indicator for commercial property is high, but has edged down over the past year. The share of wholesale funding has increased recently and is now close to the elevated level prevailing prior to the financial crisis.
The indicators of financial imbalances are at historically high levels. They are also higher than most of the estimated long-term trends. This suggests that there has been a build-up of financial imbalances that may trigger or amplify an economic downturn. Recent developments indicate that imbalances are no longer building up at present. There are signs of some easing of banks' credit standards for households. Should house prices again rise faster than household income and debt accumulation accelerate, systemic risk may increase further ahead.
At end-2013, the Common Equity Tier 1 (CET1) capital ratios of the largest banks were 1–2 percentage points above the requirement as from 1 July of this year. Banks also posted solid first-quarter earnings.
Norges Bank gives weight to the fact that a large number of regulatory changes are being implemented simultaneously. The decision of the Ministry of Finance to designate DNB Bank and Nordea Bank Norge as systemically important banks implies a further increase in the capital requirements for these two banks in the period to 2016. The large savings banks will, nonetheless, likely also have to adapt to the highest capital adequacy requirements.
Norges Bank is of the view that the decision basis does not support a change in the buffer requirement at this time.
If there are signs that financial imbalances continue to build up, Norges Bank will issue advice to increase the buffer rate. The buffer rate should not necessarily be reduced even if there are signs that financial imbalances are receding. In long periods of low loan losses, rising asset prices and credit growth, banks should normally hold a countercyclical capital buffer. Any future advice to reduce the buffer rate will be based on an assessment of market turbulence, loss prospects for the banking sector and the risk of a credit-driven downturn in the Norwegian economy.