Financial Stability 2/2004
Summary
Strong global growth has strengthened the financial system
Stronger economic growth, low inflation and very low interest rates have strengthened global financial stability since Financial Stability 1/2004. The economic upturn in most regions has reduced losses and increased earnings in banks and among other financial sector participants. The ability of the financial sector to absorb economic shocks has been strengthened. Households and enterprises are benefiting from higher income and low interest rates.
It is uncertain how long this strong economic growth will continue. Equity prices in the largest markets have not risen over the past half year, despite higher economic growth. The decline in long-term interest rates in recent months may indicate that growth expectations ahead are more subdued. In the longer term, the strong growth in house prices and household debt in many countries may represent an element of uncertainty regarding economic developments.
Chart 1
Sharp fall in Norwegian banks’ loan losses
Results in Norwegian banks are better than they have been for several years. This is attributable to the very low level of interest rates and a marked pick-up in economic growth. Loan losses have dropped sharply. Increased income from securities trading and other services and lower operating costs have also contributed to improved results.
Chart 2
Persistently high household credit growth
Household debt is still growing rapidly, and more rapidly than household income. Debt in relation to disposable income is now approximately as high as it was in the early 1990s. However, low interest rates are contributing to a very low debt burden. Households’ wealth has increased more than their debt in the past year, so that household net wealth has increased. This marks a distinction from developments in the period prior to the most recent banking crisis, when strong debt growth partially financed consumption, and savings fell.
Debt and wealth are unevenly divided between income classes. Those with lower income have increased their debt most in relation to income since the late 1980s. At the same time, their financial reserves (assets in relation to debt) have declined.
Chart 3
Improved corporate profitability
More moderate wage growth, strong productivity growth, low interest rates and a marked economic upturn are improving corporate profitability. The number of bankruptcies is continuing to fall. Low investments and a sound ability to finance investments with their own capital have resulted in very low and at times negative growth in enterprise sector debt over the past year. In recent months debt has increased again. Predicted bankruptcy probabilities fell from 2002 to 2003. The improvement was most pronounced in commercial services and property management, both of them industries with substantial bank loans.
The commercial property market has improved. Rental prices for office buildings appear to have levelled off, while the increase in vacant space has come to a halt. Sales prices for office and commercial premises have also increased further.
Chart 4
Banks more vulnerable to developments in households
Banks’ lending to households as a share of total lending has increased sharply in recent years, while the share of lending to enterprises has fallen correspondingly. This is largely due to cyclical developments. Adaptation to new capital adequacy rules (Basel II), with greater differentiation on the basis of risk than is the case today, may also have played a part. Under the new regulations, mortgage-backed loans will have a lower risk weight. This may be a reason why banks want more of this type of lending. Loans to small and medium-sized enterprises will also have a lower risk weight under the new capital adequacy rules. This change can hardly be attributed to the actual uncertainty associated with these loans (cf. analyses of the historical risk associated with loans to small and medium-sized enterprises, see box on page 30).
Chart 5
Liquidity risk remains relatively low
Banks’ financing has changed little since Financial Stability 1/2004. Despite a low interest rate level, deposits from households and enterprises constitute a relatively stable share of gross lending. Savings banks (excluding DnB NOR) have increased their bonds, and thereby their stable funding. Liquidity risk is still assessed as being relatively low.
Chart 6
In the short term, banks face lower overall risk
The solid profits achieved are enabling banks to increase their financial strength. As a result of the low interest rate, households have a low interest burden despite high debt growth. The risk of higher losses on loans to households is therefore considered to be relatively low in the short term. As a result of sound developments in the enterprise sector, the credit risk associated with loans to enterprises is assessed as relatively low, and somewhat lower than half a year ago. The market risk and liquidity risk facing banks is also assessed as unchanged and relatively low. Overall, this means favourable prospects for banks in the period ahead. Against this background, the short-term outlook for financial stability is regarded as satisfactory and somewhat improved compared with the situation six months ago.
Households’ persistently high borrowing represents an element of uncertainty regarding economic developments a few years ahead. It may prove to be particularly challenging for borrowers to assess their debt-servicing capacity over time at a time when the interest rate is as abnormally low as it is now. Such a low interest rate also places particular demands on banks in assessing the creditworthiness of the borrowers.