Financial Stability 1/2004
Summary
Cyclical upturn and reduced global vulnerability
Growth in the world economy has picked up and earnings in listed companies have increased since Financial Stability 2/2003. Share prices in the largest markets have varied this year, but since the bottom in March 2003, prices have risen by 40-50%. The financial position of financial institutions, enterprises and households has strengthened, even though the value of both share and bond holdings has declined somewhat recently. The banking industry in many countries has recorded favourable results. On the whole, the vulnerability of the global financial system has been reduced. There is still uncertainty associated with the consequences for financial markets of the large imbalances in the US economy and an expected increase in interest rates internationally.
Chart 1
Improved performance at Norwegian banks
Norges Bank’s key rate has been lowered by 0.75 percentage point since Financial Stability 2/2003 and by 5.25 percentage points since December 2002. Stronger economic growth, partly as a result of lower interest rates, and an upswing in stock markets have made a positive contribution to bank performance in Norway. Banks’ securities income has shown a marked increase and recorded loan losses have fallen. In addition, banks have reduced their operating expenses. On the other hand, the fall in interest rates has reduced banks’ net interest income. Bank profits increased between 2002 and 2003, with a further improvement in the first quarter of this year. Performance in 2003 was nevertheless weaker than in the period 1993-2001.
Chart 2
Continued high growth in credit to households
Credit growth has slowed somewhat since Financial Stability 2/2003. The difference in the rate of growth in credit to enterprises and households is widening. Enterprise debt has fallen. Household debt is still accelerating rapidly and far more rapidly than household income. The sharp rise in the value of dwellings in recent years is an important explanatory factor. Historically, house prices are high. After falling in the spring of 2003, house prices rose sharply in the latter half of the year. In recent months, however, the rise in house prices has slowed.
The interest rate decline has increased households’ capacity to service their rapidly growing debt. At the same time, household financial wealth has increased. Debt and assets, however, are unevenly distributed among households. The increasing debt thus increases the vulnerability of households to economic disturbances.
Chart 3
Improved prospects for enterprises
The fall in interest rates and stronger economic growth have increased enterprises’ debt-servicing capacity. Corporate profitability improved between 2002 and 2003 as a result of increased turnover, rationalisation, lower interest expenses and a weaker krone exchange rate. The number of bankruptcies has fallen from the peak level in the second quarter of last year. Measured in terms of market value, the bankruptcy peak was reached in the latter half of 2002.
The property industry accounts for the largest share of bank lending. Enterprises that rent out office premises have been vulnerable in recent years as a result of falling rental income and property values. Other types of property enterprises have a higher level of earnings. The financial vulnerability of enterprises as a whole is assessed as moderate and somewhat lower than six months ago.
Chart 4
Unchanged liquidity risk
Banks have increased their share of stable funding somewhat since Financial Stability 2/2003. Increased bond debt has more than offset the fall in the share of funding from customer deposits. With the current low interest rate level, the share of bank funding from customer deposits is likely to continue to fall. It may be a challenge for small and medium-sized banks to procure alternative, competitive long-term financing. For banks as whole, liquidity risk is assessed as relatively low and roughly unchanged since Financial Stability 2/2003.
Chart 5
Satisfactory loss absorption capacity in the banking sector
With the economic outlook for 2004-2006 presented in Inflation Report 1/2004, banks will have a satisfactory capacity to maintain a capital ratio in excess of the statutory minimum requirement, even with relatively weak pre-loss profits. A pronounced economic downturn will have to occur for capital ratios to fall to the statutory minimum requirement. High growth in mortgage lending has reduced banks’ equity ratios in recent years. Because housing loans have a low risk weight in the calculation of banks’ capital adequacy ratios, their Tier 1 capital ratios remain virtually unchanged.
Satisfactory financial stability outlook
A lower interest burden and stronger economic growth have strengthened the debt-servicing capacity of the household and enterprise sectors. At the same time, household debt is expanding at a rapid pace. This has increased the vulnerability of households to future economic disturbances. Enterprises are continuing to reduce debt. Rising capacity utilisation in the economy should lead to renewed growth in investment, with an attendant increase in enterprise debt.
On balance, the short-term outlook for financial stability is satisfactory and has improved somewhat compared with the situation six months ago. However, the increased vulnerability of the household sector is an uncertainty factor as regards economic developments.
Chart 6