Financial problems can emerge unexpectedly, spread rapidly and give rise to substantial economic costs. The authorities seek to prevent financial crises and have elaborated contingency plans so that they are prepared to manage a crisis. Crisis preparedness is an important part of Norges Bank’s work on financial stability.
Contingency planning for the payment system
Central banks have a special responsibility to ensure that payment systems function at all times and that society’s needs for notes and coins are also met in extraordinary situations. Norges Bank works on payment system preparedness, which also includes the supply of notes and coins, as well as externally with regard to financial sector infrastructure, including in its role in authorising and overseeing interbank systems.
Each financial sector participant has an independent responsibility for reducing the risk in its own operations. This responsibility includes developing stable operating solutions, proper backup and preparedness procedures and systems and a robust financial infrastructure.
Norges Bank’s payment system preparedness work is closely tied to its responsibility for promoting an efficient payment system and ensuring financial stability. This applies internally to the central bank’s own systems, including Norges Bank’s settlement system (NBO), as well as externally to financial sector infrastructure, including the power to authorise and oversee interbank systems.
Contingency Committee for Financial Infrastructure (BFI)
To ensure optimal coordination of preparedness efforts among financial infrastructure participants, the Contingency Committee for Financial Infrastructure (BFI) was established in October 2000. Norges Bank sits on the committee along with Finanstilsynet, Finance Norway (FNO), Nets, EDB Business Partner ASA, Verdipapirsentralen ASA and others.
The committee’s primary tasks:
- Arriving at and coordinating actions to prevent and resolve crises that can seriously disrupt financial infrastructure.
- Overseeing necessary coordination of financial sector preparedness matters, including within the civil defence system
Lender of last resort
Central banks have traditionally acted as lender of last resort (LLR). This means that when liquidity demands cannot be met from other sources, the central bank can provide extraordinary liquidity to individual banks or the wider banking system.
Norges Bank can supply extra liquidity to the banking system or individual banks in the event of liquidity problems. An extra supply of liquidity to the banking system may be appropriate when it is clear that the liquidity problems are only temporary and are not caused by more fundamental problems. If a large supply of liquidity is required, collateral requirements may differ from those laid down in the Regulation on banks' access to loans and deposits in Norges Bank etc. (the "Lending Regulation"), cf. Section 9.
Extraordinary liquidity for individual banks may be relevant if liquidity problems are limited to one or a few banks with more fundamental problems. Norges Bank may then extend loans on special terms (S-loans) to improve these banks' liquidity. The legal basis for making such loans is Section 19 of the Norges Bank Act.
The extraordinary liquidity that Norges Bank can provide may prevent problems from spreading and thus prevent a more serious crisis. However, banks' access to such liquidity support may also influence banking behaviour. If banks are confident that central bank funding will always be available, they may take greater risks than otherwise. Norges Bank therefore acts on the assumption that extraordinary liquidity should be reserved for situations where financial stability may be in jeopardy without such support.
Another important principle for providing extraordinary liquidity is that Norges Bank should not take on more credit risk than normal. The central bank is lender of last resort, as affirmed by the Storting after the 1990s banking crisis. In such situations, loans provided by Norges Bank should therefore be fully collateralised or guaranteed.
During the most recent financial crisis, Norges Bank provided S-loans to the Norwegian Banks' Guarantee Fund in connection with a short-term loan the guarantee fund made to Glitnir Bank ASA.
Cooperation among government authorities
When financial crises occur, central banks work closely with other government authorities, especially Finanstilsynet and the Ministry of Finance. In the event of systemic crises, the authorities will closely assess the situation and take the necessary actions.
Adequate capital and liquidity buffers in banks are the “first line of defence” in any crisis management system. In Norway, the Norwegian Banks’ Guarantee Fund is a “second line of defence”. The Fund shall insure customers’ deposits (up to NOK 2 million) if a bank is forced to close. The Fund can inject equity and provide loans to a distressed bank if this is a better solution than liquidating the bank and paying deposit insurance claims.
Government authorities will be able to step in when a crisis becomes too severe for industry to deal with on its own (“third line defence”). In the event of a systemic crisis, Finanstilsynet, Norges Bank and the Ministry of Finance will assess the situation and take the necessary action. Crisis preparedness is discussed regularly at meetings of the three bodies.
The Guarantee Schemes Act provides detailed guidelines for the authorities in dealing with banking sector liquidity and solvency crises. The Act, passed in 1996, gives the authorities extensive scope for preventing crises or dealing with crises once they occur. Finanstilsynet and Norges Bank are also represented on the board of the Norwegian Banks’ Guarantee Fund, which plays a key role in dealing with bank crises in Norway.
The Nordic-Baltic countries’ central banks have concluded an agreement on managing a crisis at a bank with operations in more than one or more of the countries:
Memorandum of Understanding on Cooperation regarding Banks with Cross-Border Establishments between the Central Banks of Denmark, Estonia, Finland, Iceland, Latvia, Lithuania, Norway and Sweden (15 December 2016)
Norway has signed an agreement between all the key EU authorities (central banks, financial supervisory authorities and finance ministries) on cooperation on managing a crisis at a bank with operations in more than one signatory state:
As a follow-up, a separate agreement was signed between the corresponding authorities in the Nordic and Baltic countries:
Memorandum of Understanding on Cooperation and Coordination on cross-border financial stability between relevant Ministries, Central Banks, Financial Supervisory Authorities and Resolution Authorities of Denmark, Estonia, Finland, Iceland, Latvia, Lithuania, Norway and Sweden (pdf)