Financial Stability 1/2003
4 Liquidity risk
The term to maturity on banks’ debt in relation to the term to maturity
on their claims is decisive for liquidity risk. A high level of short-term
funding will represent a liquidity risk for banks if they do not have adequate
liquid assets. Short-term foreign financing is normally considered more unstable
than short-term domestic financing. Foreign creditors may have a lower threshold
for withdrawing funding in the event of uncertainty about Norwegian banks’
financial strength or uncertainty about national and international market
conditions.
Fall in deposit-to-loan ratio has come to a halt
Customer deposits are banks’ most important source of financing. This
source may be regarded as stable financing partly due to the deposit guarantee
scheme. For many years, this type of financing was reduced because of the
emergence of other forms of saving among retail customers. As a result, banks
had to increase the share of funding from alternative sources. In recent years,
however, the reduction in customer deposits has come to a halt, and banks’
funding in money and capital markets as a share of gross lending has remained
relatively stable (see Chart 4.1). Since the November 2002 report, the deposit-to-loan
ratio has edged up, thereby contributing to a higher share of stable financing
in banks.
Chart 4.1
High share of short-term funding makes banks vulnerable
The high share of short-term funding makes banks vulnerable because they are
dependent on refinancing a considerable share of their funding at short intervals.
Chart 4.2 shows the maturity structure for total funding in the money and
capital markets, as well as various bank groups’ borrowing from other
financial institutions. Such funding accounted for between 29% and 45% of
gross lending at the end of the first quarter of 2003. Funding that accounted
for between 8% and 21% of gross lending had to be refinanced within a three-month
period.
Chart 4.2
High share of foreign short-term funding
More than half of Norwegian banks’ short-term funding comes from foreign
sources. Banks’ short-term foreign funding accounts for about 15% of
gross lending (see Chart 4.3). Foreign funding is particularly high for the
three largest banks, while the other banks use domestic financing to a larger
extent. Loans and deposits from foreign financial institutions account for
a substantial share of short-term funding. In recent years, a number of Norwegian
banks have been acquired by foreign banks and an increasing share of funding
has come from parent banks. Deposits from parent banks will normally be a
more stable source of funding than deposits from other financial institutions.
This development means, however, that Norwegian banks have become more dependent
on developments in parent banks. At the end of 2002, the financial strength
of the largest foreign parent banks was satisfactory.
Chart 4.3
During the last six months, medium-sized banks have somewhat increased their
short-term foreign funding, which amounted to just below 10% at the end of
the first quarter of 2003. The smaller banks have reduced their exposure after
a peak in 2000, and had just below 5% in foreign funding at the end of the
first quarter of 2003.
Charts 4.4 to 4.6 show the level of short-term domestic and foreign debt (excluding
customer deposits) in relation to the level of liquid assets in the various
bank groups. The three largest banks account for the largest share of short-term
borrowing, also in relation to the level of total assets. The three largest
banks have a total short-term debt amounting to approximately 21% of total
assets, whereas short-term debt at the five medium-sized banks and the other
banks accounts for 18% and 12% of total assets respectively. The three largest
banks have a relatively large share of liquid assets on which they may draw
if refinancing possibilities deteriorate. The other two bank groups have less
short-term debt, and in addition, a smaller share of it is financed abroad.
On the other hand, the liquid assets are far lower in relation to short-term
debt than in the largest banks.
Chart 4.4 Chart
4.5 Chart 4.6
Improvement for many but not all banks
Chart 4.7 shows stable financing (defined as customer deposits, equity and
bonds) as a share of banks’ illiquid assets (lending and fixed assets).
Less stable financing and more illiquid assets result in a lower ratio. A
low ratio (liquidity indicator) means therefore that liquidity risk is high.
A value of 100 indicates that banks have balanced illiquid assets with stable
sources of funding. Since the November 2002 Financial Stability report, the
liquidity indicator for the group comprising the three largest banks has been
reduced somewhat, whereas it has increased for the two other bank groups.
Chart 4.7
Chart 4.8 shows the distribution of banks according to the value of the liquidity
indicator. Since the last report, the distribution has shifted sharply to
the right in the chart, illustrating that the improved liquidity situation
applies to a large number of banks. The number of banks with an indicator
value above 100 increased markedly until the end of the first quarter of 2003.
Similarly, the number of banks with an indicator value below 100 has declined.
However, the number of banks with an indicator value below 80 remains approximately
the same. A number of these banks are small banks, some with very low deposit-to-loan
ratios and relatively low tier 1 capital.
Chart 4.8
Considerable liquidity unrest last autumn
A number of individual banks have a very high share of short-term funding,
both through the money market and through loans and deposits from other financial
institutions. Therefore, these banks need to refinance continuously. Normally,
banks with satisfactory earnings and financial strength will not have significant
problems obtaining funding in money and capital markets. Nevertheless, uncertainty
may spread quickly if problems arise. Various incidents last autumn, and in
particular the Finance Credit case, created uncertainty as to whether individual
banks were capable of meeting their obligations. In the course of a short
period, investors in money and capital markets became less willing to provide
funding for some banks. The market for bank funding became more segregated.
While the financing situation for the largest and several of the medium-sized
banks was unchanged, some of the small and medium-sized banks experienced
problems renewing their loans. The banks that had problems were characterised
by high lending growth, low deposit-to-loan ratios, and relatively unfavourable
financing strategies which involved money market funding and/or borrowing
from other financial institutions over a long period. Thus, the problems that
arose were due primarily to conditions related to the individual bank. The
probability that liquidity problems such as those experienced by some banks
last autumn will spill over to other banks is relatively small.
Banks that base sharp growth in the lending market on short-term borrowing
will most probably have to pay for this by means of more costly, or less available,
money and capital market financing. An alternative to this type of financing
is to try to increase the deposit-to-loan ratio. Banks that experience financing
problems may be forced to increase their deposit rates to increase the deposit-to-loan
ratio. There have been signs of this in the past year. Customer deposits,
which have traditionally been an inexpensive source of financing, will therefore
become more costly for these banks. These banks’ net interest income
and results will thus deteriorate.
Satisfactory liquidity situation
Funding in money and capital markets contributes to market surveillance and
therefore has a disciplinary effect on banks. A change in the outlook for
banks will affect the terms of financing. Hopefully, this will contribute
to a more rapid correction of an unfavourable development. Increased use of
market discipline is an element of the new Basel Capital Accord which has
been proposed. Among other things, the new Capital Accord will make increased
demands on the information published by banks. This will give market participants
a better basis for evaluating risk in individual institutions.
Overall, liquidity in Norwegian banks is satisfactory. Due to the increased
share of stable financing, liquidity risk for the banking sector as a whole
is considered to be relatively low and somewhat improved since the November
2002 Financial Stability report. Nevertheless, the events of this past autumn
show that this is not the case for all banks. Liquidity risk is substantial
for small banks with a low deposit-to-loan ratio and a low level of tier 1
capital.