Advice on the countercyclical capital buffer 2015 Q3
Norges Bank's letter of 23 September 2015 to the Ministry of Finance
Norges Bank is responsible for preparing a decision basis and advising the Ministry of Finance on the level of banks' countercyclical capital buffer four times a year. On 18 June 2015, the Ministry of Finance decided to increase the buffer rate to 1.5 percent, in line with Norges Bank's advice. The rate is effective from 30 June 2016. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2015 Q3 is presented in the September 2015 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 have posted solid earnings so far in 2015, and capital ratios have risen. At the end of Q2, the average Common Equity Tier 1 (CET1) ratio for the largest banks was 13.7 percent. All of the large banks are well positioned to meet the higher requirements applicable from summer 2016. Recently, banks funding costs have edged up. Banks' losses are low.
Norges Bank's assessment of financial imbalances 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. In the post-crisis years, credit growth has decreased, but credit has continued to expand somewhat faster than GDP. Household debt is rising faster than disposable income, and credit growth has recently moved up slightly. Growth in corporate debt is more moderate. Since autumn 2014, growth in bank lending to enterprises has picked up, particularly to enterprises in the commercial property sector and construction industry. Growth in corporate bond debt has fallen. Recently, credit premiums for oil-related enterprises with a low credit rating have risen markedly.
The European Systemic Risk Board (ESRB) recommends the calculation of technical reference rates for the buffer. 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 was 0 percent in 2015 Q2. Using an alternative trend calculation method, which has been shown to provide a better leading indicator of crises, the reference rate was 1.25 percent. The ESRB stipulates that there should not be a mechanical relationship between the reference rate and the buffer rate, but that the requirement should be based on a broader decision basis.
In addition to the credit indicator, Norges Bank takes account of developments in property prices and banks' wholesale funding ratios. Over the past year, house prices have risen faster than household disposable income. The commercial property price indicator has risen markedly. Banks' wholesale funding ratios have been stable.
The persistent rise in household debt ratios and high property price inflation in recent years are signs that financial imbalances have built up. Norges Bank's assessment of financial imbalances is little changed since June. Increased capital buffers, including a countercyclical capital buffer of 1.5 percent, strengthen banks' resilience to future loan losses. In the period ahead, borrowing may be restrained by the new requirements for banks' residential mortgage lending and lower growth in the Norwegian economy. On the other hand, the decline in lending rates over the past year may entail a risk of further fuelling property price inflation and debt growth.
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).
Ida Wolden Bache