Advice on the countercyclical capital buffer 2021 Q1
Norges Bank’s Monetary Policy and Financial Stability Committee has decided to advise the Ministry of Finance to keep the buffer rate unchanged at 1.0 percent.
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 countercyclical capital buffer shall as a rule be set at between 0 and 2.5 percent of banks’ risk-weighted assets, but may be set higher in exceptional circumstances. On the advice of Norges Bank, the Ministry of Finance reduced the countercyclical capital buffer rate from 2.5 percent to 1.0 percent in March 2020. This was related to the outbreak of Covid-19 and the measures to contain it, which led to a sharp fall in activity in the Norwegian economy. A lower buffer rate reduced the risk of tighter lending standards, which could have amplified the downturn that resulted from the Covid-19 pandemic.
Banks should build and hold a countercyclical capital buffer when financial imbalances are building up or have built up. Large financial imbalances entail a risk of an abrupt decline in demand from households and businesses and large bank losses. In the event of an economic downturn that causes or potentially causes higher credit losses and clearly reduced access to credit, the buffer should be lowered to increase banks’ lending capacity. The buffer requirement should not be reduced automatically even if there are signs that financial imbalances are receding. Norges Bank’s framework for advice on the countercyclical capital buffer is described in Norges Bank Papers 4/2019. The decision basis for Norges Bank’s advice in 2021 Q1 is presented in the March 2021 Monetary Policy Report.
The Covid-19 pandemic has led to a sharp downturn in the Norwegian economy. Extensive government support measures are dampening the downturn and mitigating the risk of a more prolonged impact on output and employment. There is substantial uncertainty surrounding the economic recovery ahead. Since the December Monetary Policy Report and the previous advice on the buffer, higher infection rates and stricter containment measures have weighed on economic activity, but there are prospects for a somewhat faster upturn through 2021 than assumed earlier.
Creditworthy businesses and households appear to have ample access to credit. Banks have the capital and liquidity to maintain credit supply. In Norges Bank’s lending survey, banks reported small changes in credit standards in 2020 Q4. Issuance volumes in the corporate bond market have been at high levels, and risk premiums are close to levels observed before the turbulence intensified in March 2020.
Prior to the reduction in March 2020, the countercyclical capital buffer requirement was set at 2.5 percent against the background of a build-up of financial imbalances over a long period. Both property prices and household debt ratios are at high levels. Since May 2020, house price inflation has risen markedly and household credit growth has edged up. Commercial property prices fell in the first half of 2020, but the decline was more than reversed in the latter half of the year. The consideration of financial imbalances suggests in isolation a higher buffer requirement.
Norwegian banks are posting solid profits even though credit losses have increased. Losses in 2020 were the highest since the banking crisis. Banks’ credit losses increased markedly in 2020 Q1, but declined through the year. There is still uncertainty related to credit losses ahead. Credit losses in 2021 and 2022 are expected to be lower than in 2020, but higher than the average for the past 20 years. The Ministry of Finance has recommended that Norwegian banks limit dividend payouts until end-September 2021 and all large Norwegian banks have proposed dividend payouts in line with the recommendation. Banks’ capital ratios increased in Q4 and are well above the capital requirements. Norwegian banks are well equipped to absorb higher losses while maintaining credit supply.
Norges Bank’s Monetary Policy and Financial Stability Committee has unanimously decided to advise the Ministry of Finance to keep the countercyclical capital buffer rate unchanged at 1.0 percent. The Committee expects the buffer to return to 2.5 percent in the period ahead. On the basis of its current assessment of economic developments and prospects for bank losses and lending capacity, the Committee will advise increasing the buffer stepwise in the course of 2021.
In preparing its advice on the countercyclical capital buffer, Norges Bank has exchanged information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway).
Øystein Olsen Torbjørn Hægeland
Copy: Finanstilsynet (Financial Supervisory Authority of Norway)