The financial system is marked by high inflation and uncertainty 

There have been large and abrupt swings in financial markets since the beginning of 2022. Central banks in many countries have raised policy rates quickly to dampen high inflation. The rapid rise in interest rates has led to a fall in the value of bonds and loans with fixed rates and long maturities. This has resulted in doubts about the solvency of a number of US banks, and fuelled depositor flight from small and medium-sized US banks this year. The US and Swiss authorities have implemented measures to safeguard financial stability. A substantially higher interest rate level and the uncertain inflation outlook are adding to international economic uncertainty, as are the ongoing war in Ukraine and the geopolitical tensions. The unwinding of many central banks’ asset purchase programmes may also push up risk premiums and raise market volatility. 

The problems in the banking sector have roiled the markets but have not had any significant impact on the risk premiums of Norwegian banks or other financial institutions. Households and firms are facing higher financing costs due to higher interest rates. Growth in the Norwegian economy has slowed, but activity remains high. The labour market is tight. The growth projections for the Norwegian economy have been revised up over the past six months, but there is still uncertainty about future economic developments. The uncertainty is continuing to have an adverse impact on the financial stability outlook. 

Cyber attacks continue to represent a threat to financial stability, and it is essential to further develop resilience and contingency arrangements in the financial system to deal with such incidents. 

Owing to higher interest rates, real estate market developments are more uncertain than usual 

Vulnerabilities in the Norwegian financial system could amplify an eco­nomic downturn. High indebtedness makes households vulnerable to loss of income, higher interest rates or a fall in house prices. Higher living costs and interest rates have led to tighter finances for many households over the past year, but low unemployment and accumulated savings better equip households to meet higher expences. Household debt growth has slowed, and there are prospects of a decline in household debt burdens in the coming years. This may help mitigate vulnerabilities further out. 

House prices have risen faster than household income over time, which has increased the risk of a more pronounced house price fall. Large and abrupt falls in house prices may result in a tightening of household consumption and higher bank credit losses. House prices fell through autumn 2022 but have since edged up. Future house price evelopments are uncertain, but the potential fall is cushioned by the fairly low level of residential construction. Commercial property prices (CRE) also rose over a long period but have fallen since summer 2022, and a further decline is expected. Owing to heightened uncertainty about future economic developments and low yields relative to long-term interest rates, the forecasts for CRE prices are more uncertain than usual. 

A large share of bank loans is secured on commercial real estate. CRE firms’ financing costs have risen, but strong rental market developments and inflation adjustment of leases are dampening the impact on profita­bility. A number of CRE firms hold substantial bond debt that will soon mature. Analyses in this Report show that banks have limited exposure to CRE firms with the weakest financial strength and substantial bond debt maturing in the near future. Nevertheless, an economic downturn accom­panied by a sharp fall in selling prices and rental income may result in considerable bank losses. Structural changes in the demand for offices 

to a fall in selling prices and rental income and hence to bank losses. Moreover, CRE firms are facing regulatory changes in energy efficiency standards. The analyses in this Report show that CRE is more exposed to physical climate risk than dwellings. 

Norwegian banks are well positioned to deal with market stress and an increase in losses 

The problems in the US and European banking sector have illustrated the importance of sound risk management at financial institutions, but also of oversight and proper regulation with solvency and liquidity requirements, as well as deposit guarantee schemes. 

Norwegian banks are solid, liquid and highly profitable. Tightened risk management, capital and liquidity requirements since the financial crisis have increased the capacity of Norwegian banks to deal with market stress and absorb losses while maintaining their capacity to extend loans to creditworthy firms and households. Norwegian banks satisfy the capital and liquidity requirements by an ample margin and have a diversified funding structure with a large share of guaranteed deposits. The Norwegian scheme, which guarantees deposits of up to NOK 2m per depositor per bank, is an important contribution towards maintaining confidence in Norwegian bank deposits and ensuring financial stability. 

Solid profitability in the banking sector is the first line of defence for absorbing losses. The rise in interest rates has not led to reduced profita­bility for Norwegian banks, as for many US banks, since Norwegian banks’ assets and liabilities primarily feature a floating rate or a short fixed-rate period. orwegian banks’ net interest income has increased since inter­est rates began to rise in 2021. Bank profitability is still expected to be solid, even though losses may edge up. If financial sector uncertainty increases and spreads, it may become more costly for Norwegian banks to obtain wholesale funding. This may in turn lead to increased borrowing costs for households and firms. 

In the event of a sharp downturn, credit losses may become so large that bank profitability turns negative, and banks drawn down the capital buffers that they have built up. The capital requirements banks are facing reflect the vulnerabilities in the Norwegian financial system. The vulnera­bilities are little changed over the past six months. Stress tests and sensitivity analyses, including those in Financial Stability Report 2022, show that banks are resilient and are capable of absorbing losses and maintaining lending, even in the event of a sharp economic downturn. The countercyclical capital buffer rate of 2.5% makes a contribution in this regard. 

Overall, the financial stability outlook has not changed substantially since the previous Report in November. On the one hand, economic growth prospects in Norway have improved somewhat over the past six months. On the other hand, problems at some banks abroad have led to large movements in financial markets and the outlook for both the markets and the economy ahead is uncertain.

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