Norges Bank

Assessment of financial stability 2022

Weaker financial stability outlook

Spillovers in both Europe and globally from the ongoing war in Ukraine and the after-effects of the Covid-19 pandemic are considerable. There is substantial uncertainty about the economic outlook. The Norwegian financial system has so far coped well with the situation, but the financial stability outlook has weakened.

High inflation, higher interest rates and a weaker growth outlook have led to a fall in global financial markets. Activity in the Norwegian economy is high, and unemployment is at a historically low level. At the same time, there are signs that some areas of the economy are cooling down, in the housing market for example, where prices have fallen in autumn.

“Over the past year, the risk of a downturn in the Norwegian economy has increased, and the financial stability outlook has weakened”, says Deputy Governor Pål Longva.  

House prices have risen faster than household income, and household debt is high, which makes households vulnerable to loss of income, higher interest rates or a fall in house prices. If many households reduce consumption sharply, firms’ earnings are impaired and banks may face higher losses on corporate exposures. This constitutes a risk to the financial system.  

“Many households are highly indebted. Higher interest rates and living costs imply tighter finances for many, but the Bank’s analyses show that the vast majority of households are able to service their debt”, says Deputy Governor Longva.

It is essential for financial stability that banks and other financial system participants are able to perform their tasks effectively even in the event of severe downturns and economic crises. The stress test in Financial Stability Report 2022 shows that banks will weather a sharp contraction without having to tighten lending and thereby amplify a downturn.

“The financial system is assessed to be well equipped to address the risks we are facing. At the same time, it is especially important for the financial system to maintain a high level of resilience”, says Deputy Governor Longva.  

Tightened capital and liquidity requirements over many years have better equipped banks to deal with crises. Norges Bank has previously decided to raise the countercyclical capital buffer to 2.5 percent from 31 March 2023. The Bank has also advised the Ministry of Finance to maintain the systemic risk buffer (SyRB) at 4.5 percent. The vulnerabilities that the SyRB is intended to address are, in the Bank’s view, broadly at the same level as when the SyRB was last evaluated in 2020. In the aggregate, the regulatory requirements help to ensure that Norwegian banks hold sufficient capital.

Cyber attacks on critical functions may be a threat to financial stability. The financial infrastructure is secure and efficient, but the threat landscape has become more aggressive and more difficult to gauge. This requires an intensive effort to identify risks, regulation and extensive cooperation between various authorities and financial system participants.

Published 9 November 2022 10:00

Weaker financial stability outlook

Spillovers in both Europe and globally from the ongoing war in Ukraine and the after-effects of the Covid-19 pandemic are considerable. There is substantial uncertainty about the economic outlook. High inflation, higher interest rates and weaker growth prospects have resulted in substantial financial market volatility and has increased the risk of an economic downturn. The Norwegian financial system has so far coped well with the uncertain situation, but the financial stability outlook has weakened.

Vulnerabilities can amplify a downturn

Higher borrowing costs and higher electricity and food prices will be a challenge for many households, but most will be capable of servicing their debts. At the same time, new serious incidents can occur. Financial system vulnerabilities, such as the considerable rise in property prices in recent years and the high debt levels among households, may amplify a downturn in the Norwegian economy.

The financial system is resilient

It is now especially important that the financial system remains resilient so that it can perform its tasks effectively also in the event of severe economic downturns and crises. In Norges Bank’s view, the Norwegian financial system is well equipped to deal with market stress and higher losses. This year’s stress test indicates that banks can weather a sharp economic downturn without having to tighten lending, thereby amplifying a downturn. Norges Bank has advised the Ministry of Finance to keep the systemic risk buffer (SyRB) unchanged at 4.5%. This will help banks to maintain good loss-absorbing capacity.

Published 9 November 2022 10:00

Financial stability outlook

There are considerable spillovers in both Europe and globally from the ongoing war in Ukraine and the after-effects of the Covid-19 pandemic. There is substantial uncertainty about the economic outlook and about how economic agents will respond to higher interest rates and increased costs. The risk of a downturn has increased, and the financial stability outlook has weakened. Financial system vulnerabilities, such as the considerable rise in property prices in recent years and high debt levels among households, may amplify an economic downturn.

The Norwegian financial system has so far weathered the substantial volatility in financial markets. Solid profitability, capital adequacy and liquidity ensure that banks are resilient, with ample capacity to absorb losses and deal with market stress. It is now especially important that the financial system remains resilient so that it can perform its tasks effectively also in the event of severe economic downturns and crises.

Weaker financial stability outlook

The global growth and inflation outlook is highly uncertain. Russia’s invasion of Ukraine and the decline in Russian gas supplies to Europe have resulted in high energy prices. Along with strong demand for goods and services and supply-side constraints owing in part to the pandemic, this has led to a surge in consumer prices globally and in Norway. Central banks have raised policy rates to dampen inflation. Activity in the Norwegian economy is high, and unemployment is at a historically low level. At the same time, there are signs that some areas of the economy are cooling down, in the housing market, for example, where prices fell in autumn. Meanwhile, high energy prices are generating record revenues in the oil and gas sector.

The geopolitical situation and uncertainty about the economic outlook have resulted in substantial financial market volatility. Impaired liquidity on many trading venues, also in markets regarded to be the most liquid, has added to the volatility. Over the past year, long-term interest rates and credit premiums on corporate bonds have risen and global equity indexes have fallen. Price volatility in some derivatives markets, which has led to very large margin calls, has created liquidity challenges for many participants globally. Robust trading venues and market participants are the first lines of defence against market stress, and participants must have adequate systems and contingency arrangements for managing liquidity and counterparty risks.

Against the background of a heightened risk over the past year of an economic downturn or other adverse events, it is Committee’s assessment that financial stability outlook has weakened.

Vulnerabilities can amplify a downturn

Owing to vulnerabilities in the Norwegian financial system, a downturn or market stress may have more serious consequences for financial stability. Vulnerabilities are broadly at the same level as at the time of Financial Stability Report 2021, but an increased risk of a downturn implies a greater risk that vulnerabilities materialise. Many households are highly indebted and the vast majority have floating-rate loans. Household leverage is close to a historically high level, and it is high compared with other countries. Higher interest rates and living costs imply tighter finances for many, but the Bank’s analyses show that most households are able to service their debt. High indebtedness makes households vulnerable to loss of income, higher interest rates or a fall in house prices. If many households reduce consumption sharply, firms’ earnings are impaired and banks may face higher losses on corporate exposures. This constitutes a risk to the financial system. A sharp fall in house prices may also lead to substantial bank losses on non-performing residential mortgages of households with a high debt-to-value ratio.

Norges Bank is of the opinion that the Lending Regulation has limited the build-up of household sector vulnerabilities and that the Regulation should continue to apply largely unrevised at present. A broad review of the Regulation should be conducted before it expires in 2024, based on the experience of higher interest rates ahead, among other things.

Banks’ exposures to commercial real estate (CRE) are substantial, and in autumn, property prices have edged down. An economic downturn with a fall in selling prices and rental income may have a substantial impact on this sector and result in large bank losses. Owing to low yields on commercial property, selling prices are vulnerable to higher interest rates and lower risk appetite.

House prices have risen faster than household income over a long period. Prices have fallen this autumn, and the same tendency has been observed in other countries. The projections in the September 2022 Monetary Policy Report point to a moderate fall in house prices in Norway in 2023. Owing to uncertainty about macroeconomic developments and households’ response to higher interest rates, the forecast for house prices is more uncertain than normal. Sharp and sudden declines in house prices may trigger a tightening of household consumption and increase losses on banks’ loan portfolios.

Covered bonds issued by other Norwegian banks account for a substantial portion of banks’ liquidity reserves. This implies that problems at one bank can more easily spread to other banks. If markets are stressed, sales of liquidity reserves to meet liquidity needs may result in greater spillovers than if banks did not have cross-holdings of covered bonds.

The financial infrastructure is secure and efficient. The threat landscape in recent years has become more aggressive and more difficult to gauge. The number of cyber attacks has risen, and they are used as weapon of war and armed conflict. Cyber attacks on critical functions may be a threat to financial stability. There is broad international agreement on the need to strengthen resilience to cyber attacks on the financial sector. This requires an intensive effort to identify risks, regulation and extensive cooperation between various authorities and financial system participants. In collaboration with Finanstilsynet (Financial Supervisory Authority of Norway), Norges Bank has introduced the TIBER framework for testing cyber resilience in the financial system.

Climate change is one of society’s greatest challenges. Financial institutions must ensure that they are well equipped to assess and mitigate climate risk. Banks’ exposures to the sectors with the highest greenhouse gas emissions are modest, but other firms will also be affected by the climate transition. Well-functioning financial markets are vital for financing investment that can mitigate climate change. Adequate information about climate risk is also important. Energy labelling of buildings makes it easier for banks to assess the climate risk associated with real estate loans. Analyses in this Report show that the share of energy-labelled commercial buildings is low and should be increased. In addition, higher electricity prices make energy efficiency more important in the real estate sector, and the willingness to pay for energy-intensive buildings may fall.

It is important for the financial system to remain resilient

Overall, the financial system is judged to be well equipped to address the risks we are facing. Tightened capital and liquidity requirements over many years have better equipped banks in Norway and many other countries to deal with crises. Norwegian banks’ solid earnings are the first line of defence for absorbing losses and give banks the flexibility to lend to creditworthy firms and households. Banks’ profitability is expected to remain solid, but the risk of losses has risen.

The stress test in this Report shows that the largest Norwegian banks as a whole are capable of absorbing losses in the face of a sharp downturn in an environment where inflation is significantly higher than it is today. In the stress scenario, high living costs and interest rates hit households hard, and banks incur losses. On the other hand, some firms will benefit from high commodity and energy prices. This cushions losses on commercial loans somewhat, but banks still incur significant losses owing to a sharp fall in property prices and belt-tightening by a large number of households. The stress test shows some of the many possible adverse events that the financial system may face and outlines a possible outcome of how the financial system copes with a sharp, but not inconceivable, downturn. The current situation makes it especially important for the financial system to maintain a high level of resilience, so that it can perform its tasks effectively even in the event of severe downturns and economic crises.

Capital buffers help facilitate bank lending during crises too

Increased bank capital promotes financial stability because it reduces the risk that banks contribute to amplifying a downturn. Sharp economic downturns may result in such large credit losses that banks dip into their capital buffers. Stress tests and sensitivity analyses show that Norwegian banks’ current capital levels are high enough for them to cope with scenarios where losses are considerable. Capital levels are also in line with what analyses show to be the level of capital banks should hold in the long term. Bank capital levels that are too low are more economically costly than if bank capital should prove to be too high.

In 2021, Norges Bank was given responsibility for advising on systemic risk buffer (SyRB) requirement. In June, the Bank published a framework for that advice. The SyRB helps to ensure that banks hold sufficient capital to weather future downturns. Structural vulnerabilities in the Norwegian financial system are broadly at the same level as in 2020, when the SyRB was set at 4.5%. The current level of the SyRB should therefore be maintained.

The countercyclical capital buffer (CCyb) will be set at 2.5% from 31 March 2023. In the aggregate, the buffer requirements help to ensure that Norwegian banks hold sufficient capital.

Ida Wolden Bache
Pål Longva
Øystein Børsum
Ingvild Almås
Jeanette Fjære-Lindkjenn

25 Oktober 2022

Published 9 November 2022 10:00
Published 9 November 2022 10:00

Related information

Advice on the systemic risk buffer (Letter to the Ministry of Finance)

Norway's financial system 2022