Financial Stability 2/2003
Summary
Signs of higher economic growth
Developments in international financial markets in the summer and autumn of
2003 reflect expectations of stronger economic growth. Bond yields have risen,
and after the trough around March this year, equity prices in the largest
markets have climbed some 25-35%. The banking industry in many countries has
reported improved results this year. However, the positive trend is vulnerable
to economic disturbances, partly due to imbalances in the US economy.
Growth in the Norwegian economy came to a halt in winter 2002-2003, but is
now showing signs of picking up. The sharp fall in interest rates has contributed
to this. Norges Bank’s key rate has been reduced by 2.5 percentage points
since the May report and by 4.5 percentage points since December 2002.
Chart 1
Increased loan losses in Norwegian banks, but signs of improvement
Banks’ results in the first three quarters of 2003 were somewhat lower
than in the same period of 2002. This is partly due to sluggish developments
in the Norwegian economy, which contributed to a rise in banks’ loan
losses. However, from the second to the third quarter of 2003, banks’
loan losses fell and results improved. We expect stronger results in the fourth
quarter of 2003 than in the fourth quarter of 2002, when banks had high loan
losses and weak results. The upswing in securities markets has boosted banks’
income. This improvement reflects increased income from securities holdings,
ownership interests in life insurance companies and trading in securities.
The fall in interest rates has reduced banks’ net interest income, but
also improved borrowers’ debt servicing capacity. Banks' average core
capital ratio declined somewhat from the third quarter of 2002 to the third
quarter of 2003, partly due to high lending growth in many banks. Many banks
have issued preferred capital securities and increased their subordinated
loan capital to boost their financial strength.
Chart 2
Continued high credit growth for households
Growth in total credit and domestic credit has slowed somewhat since the
previous report, but credit to mainland Norway as a percentage of GDP has
increased to a historically high level. Household debt is increasing sharply,
while enterprise sector debt is expanding at a moderate pace. The sharp rise
in the value of dwellings in recent years is one of the main factors behind
the marked growth in household debt. After falling somewhat through the spring,
house prices have been on the rise again since the summer, and are at historically
high levels.
Chart 3
The fall in interest rates has improved households’ debt servicing capacity.
Banks’ credit risk associated with loans to households is therefore
reduced and assessed as relatively low. At the same time, household debt has
been growing far more strongly than household disposable income for a number
of years. The debt burden has therefore increased substantially. If debt continues
to increase at the same pace as today, the debt burden will pass the level
in the previous banking crisis in the course of 2005, which would increase
households’ vulnerability to economic disturbances.
Chart 4
Fall in interest rates eases corporate debt servicing
Sluggish developments in the Norwegian economy through 2002 and into 2003 contributed
to a sharp rise in the number of bankruptcies. The increase in the number
of bankruptcies has since slowed, and in the third quarter of 2003 the number
fell. Many small entities have gone bankrupt. The total market value of bankrupt
entities has fallen since the peak in the third quarter of 2002.
The fall in interest rates has improved enterprises’ debt servicing capacity.
An economic upturn will have the same effect. The property industry is the
largest recipient of bank loans. Because earnings are low, we consider the
risk associated with parts of the property industry to be relatively high
and unchanged from our assessment in the May report. Enterprises in some industries,
such as fish farming and commercial services, are still exposed. For the enterprise
sector as a whole, the estimate for expected loss per krone of debt remained
roughly unchanged from 2001 to 2002. Although financial vulnerability differs
across industries, overall vulnerability is assessed as moderate, and somewhat
lower than six months ago.
Somewhat lower liquidity risk, but mixed picture
Banks have increased their share of stable financing to some degree since the
last report. For a number of small and medium-sized banks, this is partly
due to an increase in the risk premium they have to pay for short-term financing.
Overall, liquidity risk for banks is regarded as relatively low and somewhat
lower than in May. However, the liquidity risk for some small banks is higher.
Chart 5
Lower counterparty risk
Few of banks’ exposures to counterparties are so large that the banks
would have serious problems with financial strength if a major counterparty
could not meet its obligations. A relatively limited share of the exposures
are to large Norwegian banks. This means that there is limited risk of liquidity
and solvency problems spreading across Norwegian banks. This risk has decreased
since September this year, when NOK was included in the international foreign
exchange settlement system, CLS.
Outlook for financial stability somewhat improved
Overall, the outlook for financial stability is considered to be satisfactory,
and somewhat more favourable than in May 2003. At the same time, there is
a risk that over time, growth in household debt may lead to increased loan
losses for banks. A higher debt burden makes households more vulnerable. A
sudden debt consolidation among households would reduce the earnings and debt
servicing capacity of many enterprises.