Financial Stability 2/2004
Low loan losses result in solid bank profits
1
Economic developments this past year have been favourable for the financial sector. An unusual combination of sound economic growth and very low interest rates have strengthened the ability of households and enterprises to service their debt.
The earnings of Norwegian enterprises are currently solid. Investment is gathering pace. Debt is increasing after a period of slow and to some extent negative growth. The credit risk associated with banks’ lending to enterprises is assessed as relatively low.
Household debt is continuing to increase at the same pace as previously. House prices are also rising rapidly. As a result of strong growth in financial assets, low interest rates and a cyclical upturn, the credit risk associated with banks’ lending to households is assessed as relatively low in the short term.
Households’ persistently high borrowing is an element of uncertainty a few years ahead. Households’ financial situation appears sound, because their housing wealth and financial assets have increased more than their debt since the early 1990s. But there is a risk that house prices and prices for financial assets may fall. Moreover, the increase in debt and assets is unevenly distributed among income and age classes. Those with lower income have increased their debt burden most since the end of the 1980s, and have also reduced their financial reserves.
2
The financial system is now more robust than it has been for a long time. Banks’ loan losses have fallen to a very low level, and earnings are more solid than they have been for several years. Banks have a better understanding of the risks they take, and their risk management has improved substantially since the most recent banking crisis. With a monetary policy regime of flexible inflation targeting and more stable inflation expectations there is less risk of real interest rates and unemployment being high at the same time. The risk of a crisis in our financial system now appears to be limited.
Nevertheless, the authorities should be prepared for the possibility that new crises may arise. Norges Bank’s most important instrument in a financial crisis is its ability to supply extraordinary liquidity to an individual bank, or the banking system as a whole. If, and how, this instrument will be used, will depend on the specific crisis. However, some general principles for extraordinary liquidity support should be in place. It is important that these principles are generally known to prevent banks from basing their risk-taking on the assumption that the central bank will provide support when banks encounter liquidity problems.
The principles for the supply of extraordinary liquidity outlined by Norges Bank’s Executive Board are presented in a box in this report. A necessary assumption for such extraordinary supply of liquidity is that the functioning of the financial system itself is threatened.
Svein Gjedrem