Changes to the Lending Regulation – Norges Bank’s consultation response
Norges Bank's letter of 7 November 2022 to the Ministry of Finance.
Norges Bank refers to the consultation letter of 3 October 2022 from the Ministry of Finance requesting comments on Finanstilsynet’s (Financial Supervisory Authority of Norway) proposal for the regulation on banks’ credit standards to remain in force, albeit with some tightening. The current regulation entered into force on 1 January 2021 and will remain in force until 31 December 2024 but is to be evaluated in autumn 2022. A residential mortgage regulation was first introduced in 2015, and a consumer credit regulation was laid down in 2019.
Norges Bank also refers to a letter with analysis attachment of 30 June 2022 to Finanstilsynet, with an assessment of the Lending Regulation. The letter is an attachment to Finanstilsynet’s consultation document. In the letter, Norges Bank stated that “the regulation can continue to apply unrevised at present, but a broad review of the Lending Regulation should be conducted before it expires in 2024. Changes in the interest rate stress test should be considered based on the experience of higher interest rates in the period to 2024, and at the same time, making the interest rate stress test clearer and preferably simpler can also be considered”.
The high indebtedness of many households is a key vulnerability in the Norwegian financial system (see Norges Bank’s Financial Stability Report 2022). Household leverage is close to a historically high level. High debt makes households vulnerable to income loss, higher interest rates or a decline in house prices. If many households reduce consumption sharply, firms’ earnings are impaired and banks may face higher losses on corporate exposures. A sharp fall in house prices may also lead to substantial bank losses on non-performing residential mortgages of households with a high loan-to-value ratio.
Household credit growth edged up through the pandemic but has slowed overall since 2017. Debt developments are closely associated with changes in house prices. With the exception of an upswing through the pandemic, house price inflation has been moderate since 2017, and in autumn, house prices have fallen somewhat.
Credit regulation must strike a balance between the objective of mitigating the build-up of risks in the financial system and the objective of credit market efficiency. Requirements for banks’ credit standards may contribute to limiting excessive household borrowing and thus reduce financial system vulnerabilities. On the other hand, standardised requirements can have an undesired impact in individual cases and weaken banks’ incentives to assume independent responsibility for assessing risk. Regulation of credit standards can also lead to the emergence of new sources of credit or forms of credit that are unregulated.
Norges Bank is of the opinion that the Lending Regulation has mitigated the build-up of household sector vulnerabilities. In a period of low interest rates, the Regulation has had a dampening effect on the increase in residential mortgages with loan-to-value (LTV) and debt-to-income (DTI) ratios above the limits. The Regulation has also helped to restrain the growth in consumer loans, a form of credit associated with high risk. The flexibility quotas in the Lending Regulation enable banks to provide above-limit mortgages on the basis of a customer-specific assessment. Such quotas underpin banks’ own responsibility for prudent lending and likely reduce the cost of regulation.
It is Norges Bank’s view that prudent mortgage lending requirements should be regarded as a permanent structural measure and should not be changed frequently. This will contribute to predictability and counter future deterioration of credit standards. At the same time, it may be necessary to consider adjustments to the Regulation when the situation or agents’ behaviour changes, primarily by adjusting the flexibility quotas. Adjusting the flexibility quotas can make the Regulation more, or less, binding without changing the requirements in the Regulation.
Finanstilsynet proposes reducing the maximum DTI ratio from 5 to 4.5 times annual income. Finanstilsynet also proposes tightening banks’ flexibility quotas for residential mortgage loans, ie the percentage of these loans banks can extend that do not meet one or more of the regulatory requirements. Finanstilsynet proposes a single quota of 5 percent across Norway. The quota under the current regulation is 10 percent, except in Oslo, where the quota is 8 percent.
Norges Bank refers to its assessment in the letter to Finanstilsynet in June that “the Regulation may continue to apply unrevised at present” and is of the opinion that the requirements for maximum DTI ratio and the flexibility quotas should not be changed. Developments in the Norwegian economy since June do not alter this assessment. According to Finanstilsynet’s mortgage lending survey in 2022, around a quarter of the total amount of loans was granted to borrowers with a DTI ratio above 4.5. Reducing the maximum DTI ratio and flexibility quotas may contribute to reducing the build-up of household sector vulnerabilities. At the same time, such a tightening may limit many households’ access to financing. Norges Bank is of the opinion that the current regulation takes this trade-off into account in an appropriate manner. Lending rates have risen, and in the period ahead, higher lending rates are expected to curb credit growth, thereby mitigating the build-up of household sector vulnerabilities.
Finanstilsynet proposes extending the Regulation to include loans secured on collateral other than housing (eg car loans). Norges Bank pointed out in its letter in June that “the benefits of expanding the Regulation must be weighed against the risk that private individuals may be prevented from borrowing for business purposes”. Finanstilsynet also proposes changing the scope of consumer lending (cf. Financial Contracts Act), which will likely counter the effect of the extended Regulation to prevent borrowing for business purposes. Norges Bank supports the proposals to change the scope and extend the Regulation to loans secured on collateral other than housing.
Ida Wolden Bache